Hi all, So I've been looking into options for the past 9 months or so, reading up on volatility and practicing in toy (single contract) sizes. It's all very fascinating, and Dr Cottle's "Hidden Reality" book has got to be most interesting read I've done in a while. But I can't get rid of this nagging doubt. Take iron condors, for example, and any of the good books about them. They make it sound almost too easy. Like Benklifa's book says, just trade the math. Sell delta 10-12 two months out, buy further strikes, wait, exit, repeat. What's nagging me is if there is a statistical edge in that sort of setup, why aren't the big players doing the same in bulk and shrink the credit you receive until it's a tossup? And if the edge is not directly in expected payoff, where is it?
True, a lot of people believe being way out of the money is an edge. I studied options for about a year or so and the one thing I learned was that I couldn't find an edge. There are even a couple guys at my firm who trade options that think vol collapse from earnings is an edge.
There is no edge. It's a lot like religion. It's a system of belief. Belief is very powerful. If it can drive one to fly a plane into a building, it can certainly convince one that selling 10 delta spreads has an edge. And the funny thing about belief is that no amount of reasoning will ever change their mind. It is what it is. I wouldn't get worked up over it. Trade what you feel comfortable trading.
There is no edge in trading this type of strategy, although many people think there is. Rolling an iron condor, or any type of option trade, is not a strategy. Take a position on either price or vol.
No edge in this approach. In long term (large sample size), you are break even if no commission and slippage. With commissions, slippage and human behaviour, you will lose in long term.
Selling OTM options has a high probability but a low reward/risk ratio. If you want to develop a strategy of selling, first sell when IV is relatively high (which you know already), and look to maximize payoff instead of probability. Payoff is the product of probability and reward to risk: payoff = p*(reward/risk) The ratio is easy enough to define, but how do you calculate probability? I've posted in the past how to do a simple probability calculation, or Hoadley has a probability calculator tool as well. An options delta gives you a rough idea of the probability of ending up ITM. http://www.hoadley.net/options/options.htm example: An options delta is 0.1 and a bid of 0.05. You have a margin of say $100. Selling that option would have a payoff of 0.9*(0.05/100)
Despite all of the books and educators that imply that simple systematic selling via condors is profitable, studies reported by Jared Woodard in http://www.amazon.com/Iron-Condor-Spread-Strategies-ebook/dp/B004U7ML0Q/ indicate that it is not profitable. However, by adding some filters, he found that it is possible to come up with profitable approaches.
selling condor has positive expectancy. high prob but negative convexity. it is part of the strategy. you can call it a risk premium instead of an edge. it does not matter. think of it like selling insurance. overtime it works out. just need enough reserve capital.
Thank you everyone for the replies so far! panzerman, I understand the theory. But like they say--in theory, theory and practice are the same, but in practice they are not. Expected payoff hinges on the relationship between probability of winning and risk/reward ratio. What I don't see is how some pretty trivial math to predict the probability of winning can provide an edge for an extended period. If we can find trades with risk/reward low enough relative to the probability, and the model is simple, it will get discovered by others. As those trades get crowded, the reward will go down, risk/reward will go up, and expected payoff will drop to zero. The probability alone might still be correct, but the edge will disappear. I didn't ask the question quite right. It wasn't specifically about the edge in trading condors. They were just an example of what I read and can't quite see how it's supposed to work. It's more broadly, what real edge can an individual options trader have in the market? Or I guess what I really care about is, what do I need to work on to find my edge?
It is selling insurance. What I don't understand is it it works, why aren't there hedge funds selling it by the truckload until it stops working?