So, maybe that is the edge. Ratio credit spread. Buying way out of the money calls AND fewer ATM calls. Then make adjustments. If the underlying rises, get out at a profit. If it falls, you still win. What do you think?
Profitaker I agree, I donot sell generally for £15 (comm is only £1.70 all incl)Towards the end period I use my excess margin to make few bucks, and that also if I have made expected return on my investment.-which is 2-3% per month. osho
Using the ODDS probability cone, set to 20 days historical volatility in metastock, 4.6% chance of oil hitting 94.11 on 16/12/2005. 12.45% chance of it hitting 85 dollars on the same date.
This all assumes many trials. In the short run you can be seriously wrong on spot + implied vols and still do quite well selling premium. Stating vols are > your estimation states nothing about what will happen while holding the position, nor the closing price of the underlying at expiration. Suppose you sell 18% index vol with 30d to expiration -- the realized vols[spot] may very well exceed 18%, but they may trade in a 16%-20% range during the holding period. You may very well be + quite a few handles on an 18vol index combo in a week's time if vol remained at 18% or lower. Theta marks down vega and marks up gamma with time. IOW, the elasticity of the position allows the seller the opportunity to profit with an initial -edge, but the risk increases despite being green on P&L. The realized vol says nothing about the vol[variance] at a discrete interval. +edge is often overstated and misused; -edge is understated and a virtual-certainty, but it often has very little to do with realized P&L.
Why do you think somebody will let you short that option and why at that price, why not half that or double that price? Someone is willing to pay you the premium, ever wonderd why? Because, based on simple stochastic math and based on some estimate of the underlyings volatility, the expected avarage price of the option at expiration is..... exactly the premium you received. Ursa..
They are buying insurance or are speculating, 76% will be otm on expiry, source CME. Do Option Sellers Have a Trading Edge? By John Summa, CTA, OptionsNerd.com Contact John October 1, 2003 While there are certainly many viable options-buying strategies available to traders, options expiration data I obtained from the CME covering a three-year period suggests that buyers are fighting against the odds. Based on data obtained from the CME, I analyzed five major CME option markets - the S&P 500, eurodollars, Japanese yen, live cattle and Nasdaq 100 - and discovered that three out of every four options expired worthless. In fact, of put options alone, 82.6% expired worthless for these five markets. This study analyzes data compiled by the Chicago Mercantile Exchange (CME) for a special options report prepared for this my book, Options on Futures: New Trading Strategies (Wiley & Sons), co-authored by Jonathan Lubow, vice-president of Trader's Edge, Inc., a futures and options brokerage based in Madison, NJ. Three key patterns emerge from this study: (1) on average, three out of every four options held to expiration end up worthless; (2) the share of puts and calls that expired worthless is influenced by the primary trend of the underlying; and (3) option sellers still come out ahead even when the seller is going against the trend. CME Data Based on a CME study of expiring and exercised options covering a period of three years (1997, 1998 and 1999), an average of 76.5% of all options held to expiration at the Chicago Mercantile Exchange expired worthless (out of the money). This average remained consistent for the three-year period: 76.3%, 75.8% and 77.5% respectively, as shown in figure 1. From this general level, therefore, we can conclude that for every option exercised in the money at expiration, there were three options contracts that expired out of the money and thus worthless, meaning option sellers had better odds than option buyers for positions held until expiration. Figure 1 - Source: CME Exercised/Expired Recap For Expired Contract Report We present the data as options exercised versus those expiring worthless. Figure 2 contains the actual numbers, showing that there were 20,003,138 expired (worthless) options and 6,131,438 exercised (in the money) options. Futures options that are in the money at expiration are automatically exercised. Therefore, we can derive the total of expired worthless options by subtracting those exercised from total options held to expiration. When we take a closer look at the data, we will be able to spot certain patterns, such as how a trend bias in the underlying affects the share of call options versus put options expiring worthless. Clearly, however, the overall pattern is that most options expired worthless. Figure 2 - Source: CME Exercised/Expired Recap For Expired Contract Report The three-year averages of exercised options (in the money) versus options expiring worthless (out of the money) for the markets examined below confirm what the overall findings indicate: a bias in favor of option sellers. In figure 3, the totals for exercised (in the money) and worthless-expired options for the S&P 500, NASDAQ 100, eurodollar, Japanese yen and live cattle are presented. For both puts and calls traded in each of these markets, options expiring worthless outnumbered those expiring in the money. For example, if we take S&P 500 stock index futures options, a total of 2,739,573 put options expired worthless compared with just 177,741 that expired in the money. Figure 3 - Source: CME Exercised/Expired Recap For Expired Contract Report As for call options, a primary bull market trend helped buyers, who saw 843,414 call options expire worthless compared with 587,729 expiring in the money -clearly a much better performance by option buyers than put buyers. Eurodollars, meanwhile, had 4,178,247 put options expiring worthless, while 1,041,841 expired in the money. Eurodollar call buyers, however, did not do much better. A total of 4,301,125 call options expired worthless while just 1,378,928 ended up in the money, despite a favorable (i.e. bullish) trend. As the rest of the data in this study shows, even when trading with the primary trend, most buyers still ended up losing on positions held until expiration. Figure 4 - Source: CME Exercised/Expired Recap For Expired Contract Report Figure 4 presents the data in terms of percentages, which makes it a little easier to make comparisons. For the group as a whole, put options expiring worthless for the entire group had the highest percentage, with 82.6% expiring out of the money. The percentage of call options expiring worthless, meanwhile, came to 74.9%. The put options percentage expiring worthless came in above the average of the entire study cited earlier (of all the CME futures options, 76.5% expired worthless) because the stock index options on futures (Nasdaq 100 and S&P 500) had very large numbers of put options expiring worthless, 95.2 % and 93.9% respectively. This bias in favor of put sellers can be attributed to the strong bullish bias of the stock indexes during this period, despite some sharp but short-lived market declines. Data for 2001-2003, however, may show a shift toward more calls expiring worthless, reflecting the change to a primary bear market trend since early 2000. Conclusion Data presented in this study comes from a three-year report conducted by the CME of all options on futures traded on the exchange. While not the entire story, the data suggests overall that option sellers have an advantage in the form of a bias towards options expiring out of the money (worthless). We show that if the option seller is trading with the trend of the underlying, this advantage increases substantially. Yet if the seller is wrong about the trend, this does not dramatically change the probability of success. On the whole, the buyer, therefore, appears to face a decided disadvantage relative to the seller. Even though we suggest that the data understates the case for selling because it does not tell us how many of the options that expired in the money were winning rather than losing trades, the data should say enough to encourage you to think of developing selling strategies as your primary approach to trading options. Having said that, however, we should emphasize that selling strategies can involve substantial risk (buyers, by definition, face limited losses), so it is important to practice strict money management and to trade only with risk capital when deploying selling strategies. By John Summa, CTA, OptionsNerd.com Contact John John Summa is founder and president of OptionsNerd.com and a registered commodity trading advisor (CTA) with the National Futures Association. He has coauthored Options on Futures: New Trading Strategies and Options on Futures Workbook (John Wiley & Sons, 2001) and more recently wrote Trading Against The Crowd: Profiting From Fear and Greed in Stock, Futures and Options Markets (John Wiley & Sons, 2004). Founded in 1998, OptionsNerd.com is devoted to providing educational support to options traders, option trading advisories and managed futures account services. A former professional skier and a PhD-trained economist, Mr. Summa operates his own delta-neutral options trading CTA program. There is risk of loss trading futures and options. Past performance does not guarantee future results. Trade with risk capital only. http://www.investopedia.com/articles/optioninvestor/03/100103.asp
The article indicates that people tend to over estimate the volatility of the underlying. However, it doesn't take into account the premiums paid for the expiring options, nor the gains made on the exercised options. So it's like a trader claiming he had a 75% win percentage, but you won't know whether he's profitable or not without knowing his profit vs loss ratio.
The article is misleading in the extreme ! What does or doesn't expiry OTM is meaningless. Options are constantly exercised and closed prior to expiry. Of the open interest that does expire worthless.... that tells you nothing of profitability (or otherwise), in other words who won - buyer or writer. "Options expiring worthless" is an often quoted and very misleading statistic propounded by option writers, and generally accepted by those that don't fully understand the game.
So, maybe that is the edge. Ratio credit spread. Buying way out of the money calls AND fewer ATM calls. Then make adjustments. If the underlying rises, get out at a profit. If it falls, you still win. What do you think?
You can make a living selling options. Many do, both as incorporated firms or just private traders. I have done this for many years myself and can tell you that the ability to succeed is squarely placed on the hedges and adjustments. Some hedges need to be placed at the time of writing - creating a credit spread or ratio spread, or taking some of the underlying. Others are placed later. I would caution against "figuring it out as you go". Those who have done this for a while have a clear understanding of the effects of volatility on pricing. In a vix environment much higher than today, pricing is whole different world. It is vital to have a very specific course of action for any possible movement before any positions are opened. As mentioned here earlier, there are many considerations, including overnight lack of liquidity, gaps, correlations between indexes, economic, fundamental and geopolitical factors to name a few. Most of the discussion about the topic centers around just putting a few naked positions on and sitting back til expiry, which anyone who can open an account can do. The real edge is in the hedges and adjustments and creating large windows of high probability profitable ranges while keeping the big moves from taking you out.