No. The statistical edge works only if you survive long enough. Blowing up means "one shot". You can't survive long enough to find your "statistical" edge. P.S. My discussion on the probability doesn't mean my endorsement of naked writings without any exit strategy. [edit] You really don't know if you have a real "statistical" edge or just a "perceived" edge. Always give yourself some margin of error.
segv, Yes, those successful naked writers got the "statistical" edge by random. They didn't know. I as a so-called scientist tried to explain why they have an edge. Evolution theory tells me that those survived get their edges by random. They didn't create or develop the edges themselves. I see nothing wrong with my theory, and it agrees with evolution.
Thanks Mark - for record I think you meant "Being 'confident' does not make the market go your way. Given your impressive seniority in options trading and long term market survival I'd like to tap into your experience with another question if you don't mind. With the proliferation of derivatives and mega trading volume over the years I'd imagine you have personally seen the entire character or behavior of the market change dramatically over the years. I think I get your consistent message that the market at its core is a dangerous animal that must be respected and it can completely eat one's net-worth in an instant if its not respected and given the chance. I got bit once bad this year but should be recovered this month assuming nothing weird happens. My question is how would you characterize the way in which the options market has changed over the last 30 years and what have you personally done to adapt to its changing behavior? I know this is probably a question that you could write entire books on to answer but if you could give just an executive summary of what you think the best top 2 or 3 options techniques or strategies you use and if you prefer ETFs or specific equity option trading. Frankly I'd love to read a long term trader's sentimental journey back on how things have evolved over the last 30 years and understand what you think have been the most positive and negative changes and what you see as the future direction. For example, is it all going to crash and burn some day if hedge funds are not legislatively reeled in and we get a major market event that results in a large co-dependent financial calamity (perhaps circular dependency on each others equities) ? My lurking fear that is based on "hunch" is that a lot of the large hedge funds are so highly leveraged and cross coupled through derivatives that they could take down the entire national or even global economies if we had the correct market melt down scenario develop. Perhaps this latter topic is a separate question/topic itself. Any thoughts you'd share here or in another forum area? Thanks, TS
The implication of the Cauchy assumption is that the mean is undefined, and therefore the variance and standard deviation are undefined. A random sample from a Cauchy distribution could easily appear to be log-normal and leptokurtotic while the tails are out-of-sample. In a normal distribution we assume the probability of outliers approaches some infinitely small number, but if the distribution is Cauchy that assumption is flawed in the extreme. In other words, why is it that we do not simply sell OTM puts, buy OTM calls, and delta-hedge? Theoretical edge and positive expectancy are staring us all in the face, day after day, in the form of the skew. It is because if we change our assumptions and take the view that the underlying distribution is Cauchy, not only are FOTM options undervalued, but they are grossly undervalued. These FOTM options are far better than any lottery ticket, they are the cheapest insurance policy on the planet. To reiterate dagnyt's point, the take-away practical message here is nothing new, nothing you have not heard before. Its something that many option traders know intuitively without having some economist or mathematician explain probability distributions. It is simply to protect yourself from uncertainty in the form of owning extremely inexpensive insurance. And to uglyboy's point, yes there is absolutely a position that profits from the difference between these distributions, its called "short the atm long the wings"! Again nothing new or revolutionary. But there are some finer points embedded in this discussion that I think could be useful to some of you reading this thread. From a theoretical and practical standpoint, what is the difference between selling a FOTM credit spread, or delta-hedging with a short ATM straddle? Ignoring the risk profiles for a moment, in the latter position one experiences first-hand the model that is built into the pricing of the former, but with arguably similar expectancy. We know empirically that higher anxiety is associated with trading activity in general, even among highly experienced traders[1]. Perhaps the desire to avoid this stress is part of the motivation of so agents in seeking a purely systematic approach, or in seeking a "theoretically perfect" spread. Finally, I really got a chuckle out of the article uglyboy posted, where the gentleman from OptionVue went to the trouble of back-testing selling ATM combos and buying wings at 1 standard deviation over 5 years. He found that 65% of the positions were profitable. I mean, what were the chances of that happening, say about 68%? [1] I do not have time to dig the references, try Scholar if you are interested, or PM and I might find them later. --segv
There is a difference in "statistical" and "theoretical" edge. In the former case the edge may not actually exist, but in the latter case you could just be wrong. --segv
I concur and was just about to ask for an example of a real statistical edge. In my opinion, statistics or models used cannot be a real edge.
Right. But [inaccurate] distributions contribute to skew and therefore we are right back where we started. Some insist that FOTMs are cheap regardless of skew (or distribution). I still believe they are fairly priced as are all options based on present market opinion.