Correct. This is my point. What you are really doing is simply trading deltas, not vol!!!!!!!!!!!!!!!!!!!!!!! And if you are trading deltas, you cannot have edge per se. Unless you feel you have a directional trading system that provides you with "perceived" edge. That is what I spent hours trying to explain to FA. It's very hard for newbies and even experienced option traders alike to understand this concept. It takes a lot of introspective thought for the light bulb to finally turn on.
Mav Iâm not a newbie and Iâd like to think I have plenty of introspective thought. No ego here sir, always willing to learn. I still canât get my head around your thinking. Persevere, please.... I know you are trading Deltaâs. Let me try another angle.... As you say, delta is a function of IV. If the IV is wrong then so is the delta. If you bought the 105 calls for 20 vol the delta maybe 0.15, but if the correct vol is 30 then the delta should be 0.25. So you have a bargain, an edge, an advantage, though not necessarily a profit. Another way.... if GOOG ATM were trading at 200% vol, what would you do and why? If GOOG ATM were trading at 10% vol, what would you do and why? I think I know your answers, itâs the âwhyâ Iâd be interested in. TIA.
Profitaker, perhaps it would help if you think of "edge" as an arb per your original post. In my mind there is little to no difference between a defined edge and an arb. What mav is trying to convey is that there is a difference between a defined edge and a "perceived" edge. Defined edge will only come from keeping the spread between the options or locking in vols as in conversions/reversals i.e. almost no risk as you arent speculating on anything. This is where the casino/bookie model fits in. Perceived edge will come from some kind of a directional/vega forecast that has worked for you in the past and has yielded some positive expectancy. Sell overpriced? Buy underpriced? Sure, may work for a while and has a perceived edge per your own results. But is there risk to stop working in the future? Why perceived vs real? I'd say because it isnt guaranteed and it includes taking some greek risk due to some speculation. I personally dont think that just because something has yielded positive expectancy in the past it can be called an advantage or a true edge especially true in the cases where you carry large/unlimited event risk exposure. My 2 cents.
Rally An edge and an arb are two completely different things. One is a certainty, the other isn't. Rather like comparing chalk and cheese. If Mav is talking arb then Iâd agree with him completely. But he isnât. Profitable conversions and reversals are arbs, they are not an edge. I canât agree with that. If you take the delta as (loosely) a probability, then youâd be selling a 30% prob bet when you know the true prob is only 25%. Itâs an edge, it has to be. Somebody help !
Mav The hedge ratio (delta- Nd1) and the true probability ("to be called" - Nd2) are so close it's like splitting hairs.
profitaker, not in my circles. Perhaps we are lost in the definition of the word "edge". The word is loosely used in the trading world(particularly among equity traders) to describe what professional option traders call a "perceived" edge. A true and defined "edge" is an arb to almost all professional options traders i've met. The rest is speculation based on historical data which may or may not work on the next trade you do because you think you have the "edge". How can you say you have an edge when you dont know for a fact that it will prove to be true on your next trade? Statistics arent an edge in my opinion but that doesnt mean there arent hundreds of hedge funds doing statistical arbs which they call an edge.
No, again we are miscommunicating. The hedge ratio cannot be accurate if your earlier statement is also accurate. In other words, if we know for a fact how many shares need to be bought or sold dynamically to replicate a risk free position, there would be no risk!!!!!!!!!! That's the point. You are saying point blank that the ratio is false hence the reason you think you have an EDGE!!!!!! If you are selling an option that you think has a 25% probability of being ITM and you are getting paid as if it were a 30% bet, one of you is wrong!!!!!!!! LOL.