Well, then obviously the directional part is a matter of testing a system, tweaking it until it's profitable, consistently using it, and redesigning it if it stops working. Simple but time consuming. But what about the strike prices? Do you have some advice on picking the right strike prices? It would seem to me that you'd want to pick strike prices which are out of the money, preferrably so far out of the money that they are beneath support/above resistance on the underlying. From there, you'd buy the strike price which will give the best reward to risk ratio, somewhere around 1:3 because it's a high probability trade. Also, on all options strategies it's better to have a small bid/ask spread, obviously. Does anybody see any problems with this line of thinking?
If you look at actual quotes you will see the problem with vertical far OTM option spreads. The MM bots have it covered.
Strike price selection is part of the directional system, so to speak. You select the strike prices that you think suit your outlook for the underlying. There's no way you would get a 1:3 reward to risk ratio going far out of the money (well, obviously depends on what you mean by "far"), you would need to go closer to the money. The further out you go the worse the risk/reward ratio. For example, SPX is currently at 998.72. To get a 1:3 reward to risk ratio on a September 10-point vertical you would need to sell 1035 calls and buying 1045, or selling 970 puts and buying the 960. Those two spreads would each give you around 1:3. That's around 30 points OTM. Would you define that as far OTM? Personally, I wouldn't say that's far OTM as the SPX can cover this distance in a day or two.
Most of the time the MM 'bots' do have it covered. But occasionally you will find Bid/Ask quotes on obscure issues that can yield nice returns when you hit their quoted size. Then after getting the trade you can observe that the MM's are really pissed @ getting 'hit' and they manually adjust the B/A quotes. In late 2008 I managed to hit the MM Bot on BIL three times before they permanently fixed their problem.
maybe some of the more advanced option traders can correct me but doesn't the smile generally price in this 'strategy', ie your small wins are actually smaller than you think?
If you receive 1 pt for a vertical and you win then that win is no smaller than what you thought you were receiving. Whether the 1 pt received is a fair deal is another story.
The issue with selling verticals is that profit ( if you are right on the direction ) become larger only during very last few days.