+1 to what opt780 said. Actually plus a million. J-Law I agree that selling options can be a profitable strategy for a while it can also blow up a nanosecond after your trade is filled. The worst case scenario for a fund like taleb's is a SLOW bleed (a few percent every month) with the chance of a HUGE payoff if mr. black swan decides to grace us w/ his presence. If you are selling options the worst that can happen is you marry a bank exec and get taxpayer money to set up a risk free arb fund - er - nevermind - I meant blow up HUGE. Is it possible to sell options for a while and get out before a black swan - yes? But the prob is you (not you you, in general) don't know when it will be. Given that, I think (my own worthless 0.02 not inflation adjusted) it's better to be trade the latter strategy.
There is nothing wrong with selling overpriced options. Its like running an insurance company. You might face losses eventually which is why position sizing is crucial, at no point you could ever be under threat of having margin calls or having large losses. It shouldn't be the basis of a portfolio but just an additional strategy to boost returns a bit
I think risk management should be multidimensional. There may be other methods, but this is what I do. Prefer indexes to individual stock to minimize market gap risk. One CEO suddenly taking medical leave will not tank an index. Trade options naked, but never trade naked options. Trade spreads. Choose short strike with a low probability of not being overtaken before expiration. Only open the spread if the credit received is sufficient for the risk being taken. Place contingency orders to stop your losses in case you are not available to do so manually. Add companion spread to neutralize delta (form Iron Condor) if you are not good at predicting market direction. Trade two indexes (NDX, RUT) chosen to reduce the effects of correlation. Trade multiple time frames (weekly, near monthly and month after near month) as increased volatility affects the series closer to expiration more than ones farther away. Allocate resources among the seven buckets (three time frames for each of the two indexes and the cash reserve bucket) to reflect your risk tolerance. Use a model rather than just gut feel. Maintain sufficient cash in your account to take advantage of opportunities and deal promptly with jeopardy. Exit before expiration if underlying price is within striking distance between end of trading and settlement. Keep a journal with sufficient detail to differentiate between trader failure (didn't follow the rules whether on purpose or by accident) and strategy failure (systemic market change rendering strategy less effective or insufficiently effective for the risk assumed). Don't trade an aggressive strategy with funds that will materially affect your life style if you lose it all.
I think the insurance company analogy is exactly right. Anyone making the blanket statement that all insurance companies are "picking up pennies in front of a bulldozer" and therefore doomed to blow-up is... well obviously, very mistaken. The real key, in my opinion, is understanding the type of insurance currently being sold. Without knowing the risks being taken, you can't evaluate the skill of the manager involved. Black swan insurance is a disaster waiting to happen. Those of us living in California know, for example, that earthquake and floor insurance are prohibitively expensive from private insurers. The *only* way such policies are remotely affordable is when they're, in one form or another, subsidized by government funds. On the other hand, car insurance is both widely available, and extremely profitable for the insurance companies. If someone asked you to invest in their earthquake insurance company, on the basis of the fact that they've been consistently profitable for 5 years... you should run the other way. If on the other hand someone asks you to invest in their car insurance company after 5 profitable years... then you can have some confidence that they have some edge in their underwriting.
There is no comparison between LJM and ACE. LJM has a huge bundle of his own capital (propietary accounts) in the program and has weathered big drawdowns remarkably well. Yudee Chang of ACE is a churn and burn guy...he was charging $100 commission in his retail brokerage firm before starting his CTA...the only reason he gets new accounts is because he is a Principal of Vision (which is an FCM).
why not just sit on the bid/ask and flip it constantly as people hit you? spread can be just as much as the option price on some ootm options (if not more). If you can flip that twice you make double the money if you had of just sold it straight out and held it right?
One of the problems I have had about the "Black Swan events" is that even if you are long them, you may not profit. 2008 was a spectacular year for long volatility funds and many did quite well. But if you were systematically long SPX vol the entire year, drawdowns through the summer hurt you a lot. Another problem is that black swan events don't happen universally. Some assets outperform others by a lot. If you were long calendars in 2010 you did quite well despite being short gamma. However, in 2008 you got pummelled. I am sure the same is true for other asset classes, but I haven't studied them.
Elitist trader....(if ur not joking and are serious)not possible with options & even a rough business to be in even in stock or futures w/ access to orderflow. You end up being the buyer in sell offs & in rallies watch your long inventory get gobbled up as everyone lifts your offer. All over a spread a few cents wide. Not fun. Any MM in options will tell you options trade all over the place & infrequent at different strikes and the MM at the end of the day usually has a inventory akin to "Sanford & Son" of calls & puts at all different strikes & expirations were nothing is or even (no clear position) that just ends up pointing directionally, delta, gamma, & theta in different directions. Rare to buy the bid, sell the offer all day long in a particular option. Passarelli even puts a page or two in his text on this. If the membership of various exchanges choke on it (specialist firms on NYSE out of biz) guys at the screen on IB or whatever .....well.... Never as easy as it seems. But, it would be nice.
That game is old, I used to play it untill 6 years ago and now it's totally gone: tight spreads and cancellation costs have killed it as I know would happen. It was fun while it lasted but you'd better knew what you were doing and had a very good spreadsheet (I built my own in VB connected to realtime input) with all the greeks and other stuff for risk management. Even then you'd better used a lot of common sense on top of the math or you'd get killed anyhow ... you'd also had to be prepared to read a lot of stuffy books