Statistical edge with option spreads -none?

Discussion in 'Options' started by optionsgirl, May 13, 2009.

  1. heech

    heech

    I am inclined to believe that stat arb does exist, but it's incredibly, incredibly rare... and it's certainly nothing as simple as buying or selling a put/call/calendar/butterfly spread. To have actual statistical "edge" that you can arb, you need a better-than-average continuous model for price and volatility. To put it mildly, it's more or less the holy grail.

    For the vast majority of option traders... we're fundamentally no different than stock traders. The shape of the payoff function looks a little different, but the ultimate risk/reward ratio over time will look the same.
     
    #31     May 14, 2009
  2. vanv0029

    vanv0029

    I have been working on a philosophical argument that I think shows
    that any option strategy that does not involve predicting market direction
    (or at least expiration day ending price) losses money.

    My observation is that outcomes from the following thought experimental
    will fail any kind of spectral test, i.e. there will be no random variation.
    At the current month's expiration buy or sell the nearest strike straddle.
    At the next months expiration, underlying price will be manipulated to be
    exactly evenly distributed (ignore dividends, interest costs, etc.).
    Namely, there will be no 'statistical variation' even over a small number
    of samples. In its simplest form, exactly half of the closing prices will
    be less and half greater. In a random set of trials there should be much
    more variation. I thought of this in trying to explain why I think the
    various Cottle type straddle/strangle trades can't make money.

    I think this shows that statistics is a nonsense concept like
    signs of the Zodiac. One's Zodiac sign has some predictive power providing
    society believes in it as a convention.

    There are two cases. Statistics involving infinity is nonsense
    since no operations can be defined for infinite sets. Statistics is
    just conventions and axioms here. The ignored 20th century logician
    Paul Finsler showed this. The only algebraic operation that makes
    sense for infinite sets is one-to-one correspondence making.

    The other case is finite experiments involving human society. I think
    the right analogy for seeing option trades is to see a fixed dice game.
    The dice are magnetized and everybody has a magnet some small and some
    large. Market makers basically have the advantage of seeing retail
    magnets but no magnet of their own. The Tarp banks have both better viewing
    of magnets and large magnets themselves. This makes statistics and the
    various theorems pure fantasy.

    This also shows that no retail trader can make money even if trading
    costs are ignored from non price change predicting option trades - any
    option strategy that does not make a directional prediction will lose money.
    It also suggests that market makers can't make money unless their profit
    is tolerated by the vertically integrated and now Tarp receiving large
    magnet holding money center banks.
    ~
     
    #32     May 14, 2009
  3. this is where your assumption is wrong. The distribution of the underlying prices is NOT normal. That is one of the most fundamental issues in options trading. And this is where some of the models have the edge. Options are priced according to which probabilities the market for up and down moves implies. Those probabilities are pretty much always skewed. If you model disagrees with this skew with a statistical edge then you have a strategy with edge.

    Those are just some very basic observations after having traded options for institutional outlets for years.

     
    #33     May 14, 2009
  4. I like to add that another factor that may differentiate retail from professional traders is capitalization. I would assert that pure vol trading strategies for a retail guy/gal are impossible without at least putting USD 1 million on the line.

     
    #34     May 14, 2009
  5. ...there is no guaranteed way to make money, no matter what. So even being able to buy options below fair value and selling those above fair value can lose you money. The reasons can be many, among others, liquidity issues, overleverage, commission, and so forth. While the identification of fair value and deviations of that is the right approach many other issues need to be considered.

     
    #35     May 14, 2009
  6. spindr0

    spindr0

    Everything that you say may be totally true but extensive programming and extensive development skills aren't usually within the purview of most of the retail world which has not spent their professional life in the pits, at prop desks or in related industry positions. Ergo, we end up doing things a bit differently.
     
    #36     May 14, 2009
  7. You seem to forget that option contracts are merely created by a shake of hands of two willing parties--whereas, the equity market presumably reflects some precieve valuations.
    ~B


     
    #37     May 14, 2009
  8. I think everyone has touched on great points. Selecting strategy appropriate to the environment and managing it is the "edge." Let's suppose you believe the S&P 500 E-mini will go down a hundred points. Now the key is to select and manage your strategy. One, you would like to pick the strategy that gives you optimum profit. Since you know what is going to happen, there can be no loss (or can there be?). It looks like the best trade would be to short the futures. Now, let's suppose we always use options in our trading. So, let's say we use the covered put strategy (short the futures and sell the ATM put). Your profit will be about 60 points. Bear put spreads and bear call spreads will work, but not make as much. A DOTM bull put spread will make even less. Interestingly, if you do a long put, you could actually lose money, for the market takes too long to go down. So, we are back to strategy--picking the right one and managing it.
     
    #38     May 14, 2009
  9. Why bring MM's or tbills into the convo and why take an cheap shot?
     
    #39     May 14, 2009
  10. heech

    heech

    I personally doubt there's much alpha left in trying to arb the volatility surface. Everyone has pretty much the same option pricing models, and everything tends to move in line.
     
    #40     May 14, 2009