RM , is long ITM put ( when smile exists) is a perceived edge ? Or its a 50/50 bet with ,lets say, 52/48 payout ? In this case I don't speculate on historical data , I am betting on existing conditions only
Being long the ITM put has the same vol as the OTM call at the same strike. In other words, it the same as being short stock and long the same strike call.
of course , but I was trying to come up with one example where I don't have to use short+long action to trade vols. I meant to take advantage on stock/vols nominal inverse relationship.
IV, yes. In my opinion, pronounced skews/smiles of temporary nature could fall under the "perceived" edge just as anything else that has worked for one in the past and has yielded positive expectancy. This thread should be evidence for that. If you sold SPX puts 2 sigma out every time the vix reached 17 the past few years, you have expectancy and you have a perceived edge and yes, the puts were overpriced but do you have a true edge? Some trade on MA crossovers and call it an edge because it's yielded them in the past but in my eyes this is not a true "edge". Again, it's just that this word is so largely used in the trading community that it's easy to mislabel just by chance alone LOL I personally see nothing wrong with relying on a "perceived" edge. After all, i trade on perceived edges myself, but it can be problematic as in the case of cheap/naked gamma for obvious reasons regardless of how much edge you think you have on your side. I suppose if you don't expose yourself to a blowout by relying on your edge, it matters little whether you call it true or perceived but when you sell naked/cheap gamma, you really cant know so it's a moot point that many tend to make.
Mav I can agree with that. So are you saying that because the future volatility cannot be know in advance any edge is perceived, rather than real ?
I'm confused (again). I was under the impression that a delta of say, 32, would equal a 32 % probability of that option expiring itm. I also thought that a one standard deviation equates to a 68% probability of the underlying staying within that range til 'expiry'. Iow if I want to sell an option that is 1 SD away from atm, all I need do is look for the delta of 32. Am I misunderstanding something? Can't I just equate a 32 delta (or lower delta for that matter) with a one (or greater) SD? daddy's boy
You are correct. BUT, before you can calculate a Delta / Probability / SD, you need a volatility input - that is the future volatility, which cannot be known in advance. I think that is what Maverick is alluding to, if not, I haven't a clue what he's on about.
Hi profitaker I understand the need for vol input into the SD calculation and delta calculation. My question is really whether the two (SD and delta) are interchangable if I simply want to find the strike with a 68% (or better) probability of expiring otm. Cheers daddy's boy
DB Yes. IF the distribution is normal, and IF you input the correct future vol, then 1 x SD will account for 68% of all prices. So sell a 34 delta Put and a 34 delta call, and you will keep all the premium 68% of the time. Strictly speaking the Delta (or ND1) is the hedge ratio in continuous time. The true probability of an option expiring ITM is known as the "Probability to be called" (or Nd2) which is taken from the right side of the BS equation. However, the difference between Nd1 and Nd2 are so small (except for far dated options) that the Delta is widely taken as the probability. When I say "widely taken", I'd like to point out that there are a few exceptions