Itâs an interesting debate â who has the edge, writer or buyer. Mathematically itâs very easy to see, itâs simply a case of looking at volatility, implied and historic. If implied is higher than historic then the writer had the edge. For example, if you sold a one month option at IV 10% and then looked back at option expiry to see that the underlying historic volatility turned out to be 8%, then the writer had the edge. Sell 8% vol and historic turns out to be 10% then the buyer had the edge. Agreed ? Couple of points here⦠Most importantly it isnât possible to know in advance who will have the edge, since nobody knows future volatility (if they do Iâd like to hear from them). Secondly, having an edge doesnât translate into guaranteed profits, it is just that â an edge / an advantage. In the same way that a casino can lose money despite their having an edge, so you can lose even when selling higher IV than HV, even though you have an edge. I used to be of the opinion that writers had the edge, but now with more experience and a better understanding of the game, itâs my opinion that <b>over the long run</b> there is no significant advantage in writing, as opposed to buying options. If option writers really did have an advantage, then traders would pile in and sell options in an attempt to make the so called excess returns. The effect of so many option sellers would be to force option prices down and implied volatility with it. Option prices would then be driven down to the point where sellers would no longer have an advantage over buyers and selling options wouldnât be attractive any more. At that point, the market would be in a state of equilibrium, in other words an efficient market. You can see this taking place on an hour by hour basis, as IV moves up and down throughout the day. Incidentally, being long 20 deltaâs is very different to being short 20 deltaâs, but thatâs got nothing to do with âedgeâ. Cheers.
As Mav and Profitaker have pointed out, there is no statistical advantage in writing/buying. Just as there is no statistical advantage in random futures entries, as one example. Actually, a statistical disadvantage to all three. You either need an edge on vol or direction to earn; which can only be determined after the trade is locked[arbed] or offset. Either way involves some predicitive-capacity on the trader's part. Whether your prediction[edge] is correct is TBD[hindsight]. It's no different than any other market.
There is no guarantee of edge in mispricing, or advantage in buying 18% when ThVal is 20% unless there is a ready-made arbitrage waiting. The ThVal is a spot-vol assumption on which the option-edge is based, as well as a bet on implied vol. IOW, the edge as stated is "GIGO" To securitize the edge would require the buyer to gamma-trade spot and/or options with incremental-edge, or achieve a lock via a pricier-synthetic or other arbitrage. Spot vols will likely need to be > 18% for gamma trading to be successful. If not, then your stock trading is better than the 200basis edge in the option. In that case, you're better off sticking to stock trading.
With ya so far. Why ? Surely the spot vol need only be higher than the implied volatility purchased for "successful" gamma trading ?
That's what I stated. I was referencing another poster who was hypothetically purchasing an 18vol option with a ThVal of 20vol. Even assuming a spot-vol of >18% is no guarantee that you'll earn the daily-weekly theta from gamma trading. Many pros get greedy or trade off of S/R levels or other TA to determine spot-hedging triggers in lieu of simply trading the 1/2/3 sigmas. Many hedge too quickly and assume a reversal. Many trade on simple intuition. There are a million ways to f*ck it up.
Writing options..... The prospective revenue from both covered...and naked writing...on both stocks and indices are inviting in terms of cash flow....but here´s the catch... Writing assumes that the somewhat even time periods will be greater than the volatile time periods... And no one knows when these time periods are... Thus is the reason for simply staying long and not trying to time the marketplace.. Since trading is either short term or long term forecasting....It is usually the shortest time frame whereby forecasts are more accurate,,,which in turn the majority fail at....much less the longer run... Writers usually just wind down their capital....and face tax issues as well.... This is why you do not see writer mutual funds...they have been tried...and lost...very much out of favor.....
Sorry, I'd only picked up the back end of this thread - gotcha. Agree your last paragraph. Perhaps the best way to gamma trade (if there is a best way) would be to program trade, thereby eliminating human emotion - set a delta limit and just leave it.
I have enjoyed reading the diverging points of view as far as trading naked calls/puts versus just buying the calls and puts directly. Since, the risks are unlimited for writing calls/puts and the profits limited, doesn't it stand to reason that it is better to just buy the calls and puts where the profit is unlimited (calls) and risk is limited (buying calls/puts)??? Of course, the profits on buying puts is also limited but, your risk is also limited.
I don't trade equity derivatives, I have some equity vol sitting in my private account as part of some macro bets, but I do not trade it. So it is more of a fee. As a "system" approach person, why not sit down and make a simple OLS regression on realized vs implied volatility? Then look at a better estimate, i.e. Garman-Klass or Parkinson. Then, look at the implied vs historical day-over-day distribution. You will see that the most overpriced part of the distribution is the near wings, especially on the put side. I'm only saying this from a few snippets I overheard from the equity desk. Yes, you do need to delta-hedge, that's the whole point - gamma is rich if you can sell it for more then the cost of the delta hedging. For a "system" approach, you need to make a simulation that would include transaction costs. If you are a dealer, you can delta-hedge rather cheaply, as a retail trader you might think of setting some stop/limit orders around the stirkes. ps. Paper-trading is a good idea, especially for non-linear instruments like options. I am sure someone have mentioned it, but that far into the wings, bid/offer spread will overtake most other considerations. I don't know about equity, but in rates these could reach 10-15 normal vol that far OTM. I presume that you are not going to be making markets, so you'll hit the bids. That's why I'd be more inclined to sell gamma ATM/near OTM rather then get into 10 delta teritory. As for curtosis - you never know how much of it you are going to get, so selling or buying real far wings is a game that not many people play well for many years.