I agree with this. One must understand an edge or positive expectancy does not guarantee boatloads of free cash. Just because you are allowed to be the house in a blackjack game, does not guarantee you will have a profitable casino over the long-run. There's always blow-up risk and the heavy margin requirements lead to... "There's positive expectancy, but the risk/reward and hence the realistic returns aren't great. " Then to avoid the blow-up risk and reduce the margin requirements, an option seller will turn his "pure" strangle/straddle into the dreaded iron condor. The iron condor takes an already small edge and chops off 90% of it right out of the gates (by buying options to offset the options sold). Add in double the legs, double the commissions, and a more complicated adjustment scenario, and you've pretty much thrown all the edge in the garbage (if not more). Anyways just my opinion...
when the iron condor was adopted mm's were paying maybe 7- 9 cents a contract,and you could put on huge size with a small acct because you were hedged,they have been around since the 80's
It's not that customers and traders didn't know about the structure. Its that no one would short a ton of dgamma/dspot. There are safer ways to monetize short vol
Thanks. I'm not surprised that a mechanical entry like that was not profitable, indeed surprised that people would claim it is.
If option premiums were indeed systematically overpriced (as many here assert also), shouldn't it work? That is why he tested it, just as a base case, to see if option premiums really are overpriced to the extent that one could make money on that ground alone. Isn't that what many of the educators claim? I have watched their videos and heard advice like "Trade iron condors every month until you are good at them." Granted, many advocate ongoing position adjustments but I (and the author of the e-book) are very dubious about those also. The author of the e-book goes on to test the effect of adding volatility-screens and other additions and finds that when these are added to the base case, then there are some profitable strategies. I am mainly trying to pin down the issue of whether options (especially index puts) are or are not systematically overpriced. Some people here say they are, without providing much evidence to back up their assertion.
...but they could still be right and the study could be wrong....I am going to run back-tests myself......
First off my experience in trading options is very limited. That said, thus far I have seen that options tend to be priced higher than what the Binomial American model (which I use) indicates. IV typically is higher than the 7, 21 and 63 day HV I track. I have also seen that the S&P 500 options show a volatility smile. So if someone says options are systematically overpriced, my reaction would be yeah, ok, so what? The logic in pairs trading is to sell the overpriced stock and buy the underpriced. Where is the benefit in selling an overpriced option and hedging it with an even more overpriced option, ie the smile? I don't trade ICs but from what I have read they do best when volatility is declining. I think one can safely say that was not the case for every month in the 5 year test period.
Even assuming that vol is overpriced, with naked vol selling you are still exposing yourself to a huge DD if a shock event takes the indexes down in the first days/weeks of your program. You are essentially getting exposed right off the bat to equity-like DD when the entire purpose of selling options was to get as low a beta as possible (less correlation to the stock market). In that case why not just go long the SPX will large stops (martingale). You will get many winner with the occasional stop getting triggered. In fact, this strategy's equity curve would look very similar to a naked selling strategy (ie. not good) So you see, even if there is an advantage over time due to overpriced premium collection, that advantage will not help you if the market tanks right in the beginning. In other words, you would not have built up a large enough buffer of collected premium to withstand the drawdown. So if you are not selling condors and remain naked, you have the same problem that any other trading system has: the distribution of losses is random. Yes, the market does have mean reverting tendencies, but you cannot time exactly when or how close together market crashes can occur. So the soundness of the strategy does not hinge on whether vol is overpriced since you have not collected any at the start of your trading. If the market crashes are timed in a way that they occur wide appart, you are good, if not, you lose. If you are aiming for the market average of 10%/year you will probably do ok over time. But targeting anything above 15% gets tricky. Although I have some reservation about the liquidity that is available when it is actually needed. Tail risk is related to liquidity risk since it causes bids/asks to widen. Tail risk these days is indeed higher than it has ever been.
The only way to get an edge is to predict better than the market one of the variables which affect option pricing, and enough to overcome expenses. If you can't predict the odds of direction, timing, or volatility (implied or realised) quite a bit better than the options market on a given trade, then your expected edge is negative. It's that simple. There is no strategy in any market anywhere that has expected profits without any edge. Now, the good side of this is that if you DO have a big edge, options can often let you construct some absurdly favourable situations. Ever made 10 times your money on an evens bet? 40 times your money on a 1 in 5 bet? Those are fat odds that are hard to find through trading underlying markets alone.
You could replicate this by just buying the S&P with a bit of leverage. E.g. 150% long S&P. You would outperform for years until one year you get a margin call blow up. Only 2008, 1973-74, 1937, 1929-32, 1907 would have triggered a margin call in the last 110 years on a 150% long account, in the USA anyway. So you have a good chance of doing well, attracting client capital, and creaming off the fees by writing hidden OTM puts. In fact this would be a great business model for unethical traders. Simply leverage the S&P, throw in a few random offset positions long & short on small size to disguise your closet indexing, and write some political bullshit and trading saws in your quarterly newsletter. Outperform 4 years out of 5, funnel your bonus each year into safe haven assets. If you hit a killer bear market then just fold the fund, blame 'unforseen events', and laugh as your T-bonds go up 20%, cash in, then re-open a year or two later with an 'improved hedging strategy'. The market has just tanked 40%+ the 1-2 years before, so odds are it's another 5+ years before another repeat, that's good enough to have a big run and prove yourself as a 'comeback king'.