We all get it. Credit spread sellers are retards who over lever themselves and then blow up. You are smart because you never over-lever and can take delivery of all your stocks at once.
Wrong on all counts. Credit spread traders are not retards. Even the ones who over leverage are not retards. They may be merely poor risk managers.... or are unaware they are even using margin (let alone massive margin). As for myself, I occasionally over leverage as well. For example, when most of my stocks remain deep otm and expiration is just 1 - 2 weeks away. (I define excessive leverage for a naked put seller as, in the area of close to 2 times ones net worth,... vs 8 - 12 times for the typical spread trader strategist.) (Not that there is any leverage risk difference, between being on 8 - 12 times vs 30 times. Or to put it another way, you are not any safer, or a better risk manager, being on 8 - 10 times leverage vs 30 times. The risk is pretty much the same.) As for my ability to take delivery of all my stocks at once, yes I could, even on margin. But I would not put myself in a position of having to take delivery all at once. Hence the reason I ladder my diverse sector contracts, to expire over various months. But the point being, I could if I had to. The typical spread trader does not even have the ability to even consider that possibility for 90% of his stocks. As for my being smart,... I'm pretty sure I'm the most ignorant option trader here. If I'm smart, it's because I know my limitations, and don't dare test them until I'm ready to be tested,... in this wonderful and fascinating world of option trading we all live in.
Put Master, I know you and some other posters went back and forth in Aug and Sept (and perhaps before, and since) over the whole leveraged credit spread thing. I'm curious how you define your leverage? Is it the amount of margin required to carry your short naked puts divided by the notional value of those puts (number of short options x the strike at which you're short)? To make up some numbers, let's say you have an account that is 100% short puts. At the moment, the Net Liq Value of the account is $100K and the daily maintenance margin has been running about $50K. The notional value of the puts is $200K. Using the above, what's your leverage? Thanks.
If I had a $100,000 account and it would cost me $200,000 if everything were put to me, I would consider myself on 2 times leverage. The margin required and set aside for this or that trade is irrelevant to me. Those who only focus on the brokerage requirement, are the ones who get into trouble during those surprise "market events". I prefer to prepare for a market event in advance, vs having to try and manage it when it occurs. Why? Because when an event occurs , the VIX will spike, the IV will spike, the bid/ask will widen, and liquidity will dry up. That is the wrong time to think about managing the mess your likely to find yourself in....all as your contracts edge closer to expy day, with each passing day. And keep in mind, we will only know in hindsight, if the event lasted for days, weeks, months or years.
wow.. i wish you wouldn't have... update: the most the most counter intuitive thing in trading is leverage as it is not only measurable via a line in your account window but as well your ability to move past fundamental ideas of options... intellectual leverage..
Thanks, PM. Your comment that brought net worth (presumably liquid net worth) into a leverage discussion was interesting. Just curious to see how you measured it in a hypothetical account. Caveman - sorry if I've (re-)opened a can of worms.
I'll simply say, good luck with that "account window". Just remember, you are only as rich, and only as smart, as your last trade. If you are basing your degree of leverage use solely on that "account window", and there is a market event, your "last trade" may well end up being.... "your last trade". Did I mention....when an event occurs , the VIX will spike, the IV will spike, the bid/ask will widen, and liquidity will dry up? Not the best time to think about managing ones excessively leverage positions. Again, the issue is NOT leverage. My discussion is about excessive leverage.
I think one of the most interesting nuances of option trading is the calculation of Historical Volatility (HV) and how it misleads traders by understating true realized volatility. The commonly used HV formula looks at close-to-close prices, which ignores high/lows and path dependence. This becomes important for larger time frames used in your analysis. And because the HV formula calculates the difference in price vs mean change in price, it nets out some price movement from linear trends. A modified version of this formula is used by volX in their calculation of volatility, where they set the mean price change to zero to compute the absolute difference of price changes: http://www.volx.us/VolFormula.htm
Very interesting. Could you give a hand to folks like me who did not study calculus and want to recreate this in excel? The sigma Rt squared, would that be the sum of Rt squared for the period n days?