But those funds are using something in conjunction with theta. There are threads on ET were it has been illustrated by those wiser than me that there is "no edge". It is a factor and must be respected but it is not an edge. If theta is the only factor you are counting on it won't work. That is why random selling of prem will eventually blow up.
But it's not really about efficient markets, as it is about these two guys talking two different markets. Maymin (07:50) is doing the institutional thing -- buying/selling volatility|price -- which makes sense, as he's at the very Wall Street/institutional/market-making NYU/Stern. Sosnoff -- no stranger to selling vol as an X-floor trader -- is trading price|volatility. They spend 15 minutes trying to man-spain themselves in contradictory languages, when (22:50) Sosnoff says "[general retail trader] can't inventory vol". In their own worlds, they are both entirely correct. As far as TT and the EMH goes, if information were perfect (comprehensive, timely, free), then there would be no edge in pricing options over realized vol -- "IV-sub t" would equal realized volatility, and a broad portfolio would have zero returns as realized winners met and equaled realized losers. "Oh, well." It is the tussle between imperfect information, <infinite option mkt availability, and <infinite option demand, that spells the very existence of an *implied* volatility (above what will be realized). We *hope* for inefficiencies when we sell, we *pray* for efficiency when we buy.
There is a difference between an "edge" and "risk premium". A put skew is an example of risk premium in the market. Option sellers are getting this risk premium at a long term cost. It's not an edge. It's analogous to the yield curve. When you buy longer dated bonds you are not getting this extra free money that the curve offers. You are receiving the added interest at the risk of long term inflation. But in the short term it feels like free money. It's not. Just to clarify the differences here. Risk premium is available to all market participants. All of us can sell the downside put skew tomorrow and we will all get the same payoffs. An edge is different. It is NOT available to all of us. That's what makes it an edge. It's elusive, hard to find, and comes at great cost. Firms spend millions in research finding edges. If it were available freely, why would they do that? The idea is to find specific unique opportunities where premium is overpriced even when taken the skew into account. THAT is a completely different story.
Many funds are successful and use premium selling as their vehicle of choice. The special sauce is not that they are selling premium, do not conflate their success with the selling of premium.
I get that and again appreciate you coaching. I do have a couple of questions if you don't mind: 1. If the risk premium for put is real, as your comparison to long term bonds, and one can get a net positive return selling risk premium and am willing to accept that return, like accepting the returns of long bonds, anybody can get a positive return selling risk premium? 2. So, should I expect that overall my net profit should follow CAPM: The Beta of the put is higher than the underlying so it is riskier, being riskier, I should expect a return higher than the underlying? 3. Also, does that mean buying puts would guarantee me a net loss on average? Thanks in advance.
You are right, my post was incorrect. What I should have said in my original post was that just blindly selling this risk premium is not an edge. What I meant to say in my second reply (the one you quoted) was that there are professionals that are not dependent on market direction (delta) to succeed.
1) Of course. The issue is not the positive return. The S&P 500 has returned on avg 9.5% a year the last 100 years. Anyone can have that return if they choose to passively hold long term. The S&P 500 is not an edge. Nor are holding long bonds or selling puts. The put seller does have some disadvantages. They incur transaction costs month after month. The passive index holder does not. The put seller has a taxable event each and every month, the long term passive index holder does not. And the put seller has a different payoff distribution then the passive long term index holder. The return earned is not free, there is a proper discount rate that has to be applied which takes all these things into account. 2) It may or may not be riskier. We haven't set any guidelines. Are you selling puts with leverage? ATM? DOTM? Weekly, monthly, 6 months out? We can't make these blanket statements. 3) Again, you cannot make these blanket statements. Are you buying ITM, OTM, ATM puts? Are you buying with leverage? For example, there are many people who will take long stock risk only if they are holding long puts. These means without being long puts, they might miss out on the stock rally for fear of being long. You have to weigh the total net benefit of the overall position. For example, going into the nov election, many people opted to sell all their long exposure thinking a Trump victory would crash the market. Many instead chose just to hedge and keep their longs. Those who sold their longs did not lose any money from the puts but they also missed the 10% rally in the market. Those who bought the puts lost 100% of their value but gained 10% from the rally. Do we measure this trade by saying the long put holders lost, or the overall benefit was positive. Whenever we talk about trading we have to price in the opportunity cost of our decisions. It's not as simple as selling puts makes money and buying puts loses money.
Thank you sir. You are right, my questions showed a lack of perspective and understanding. I shouldn't be looking at the trades in isolation. This is very helpful. Best wishes.
1. Yes. One will realize this risk premium if they hold long enough. Key here is not to be leveraged. Leverage changes the profile. 2. Assuming you are selling put ATM, Beta is actually less compared to the index itself. Since you are short equity risk premium, you will have the same return as the index itself. http://www.cboe.com/micro/put/15421-put-factsheet-feb24.pdf 3. Yes. Since ERP is positive, over the long run it is bad idea to buy the insurance. That does not mean certain times it does yield positive returns. https://www.nomura.com/events/9th-a...rence/resources/upload/3_30_Nick_Firoozye.pdf