Anseld... just curious... are you a male over age 18? If so why not act like a man! I'm not interested in reading your crap and any other pissing match-commentary on a great thread like this. Comprendre? Take it out to the parking lot if that's how you get your way, bro. (final comment)
Yes, Iceman. I think Union was referring to the few comments on selling way OTM options. He was just adding that warning, which I learned the hard way. Thanks Union.
Anseld, like I said before, I also think options are not priced efficiently. Is there a way you can shed light on your methodology in finding and taking advantage of options as well as where to find them?
vulture, i'll tell you exactly where mav's entire reasoning is flawed in this thread and why his general approach to options is preventing him from discovering opportunities. throughout this time, he's been talking about neutral expectancy when you either long or short options. well, that assumption is nothing new, and it would stand true if the world is just perfect. the efficient market hypothesis (emh) has been championed by economists since the early 70s (look up eugene farma). the theoretical assumption is that, at any given time, all prices reflect all available information on a particular underlying and/or market. thus, according to the emh, no one has a particular advantage since everything is simply perfect and efficient. well, i have news for you - the options world is anything but perfect. not all markets are efficient and not all volatilities are reflective of true value. and not all marketmakers are perfect. there are thousands of options markets out there, and inefficiency occurs pretty much everyday if you just bother to scan and have a reasonable model to compare to. not all dpm's are savvy with vol adjustments. some marketmakers are quite slow to respond, and some impatiently rush to make erratic judgments, and even the public (the flow of the paper) sometimes goof with their predictions and skew things out of proportion. that's when ineffiency is created. and this is why it is just wrong and naive to assume ALL options have neutral expectancy because that idea just goes out the window when you don't even have a perfect market place to begin with. you can't always force to bring classroom textbook theory to the real world when it's not even applicable. and i'm not talking about call/put parity, but the explicit and implied volatilities. when you have an overpriced option, there IS an advantage in selling it. i'm not going to use the word 'edge' because i hate that word, and that's not really what it is. what you have is basically a greater probability to put on winning positions because the premium is so overvalued that your expected return is greater than your expected risk. you should benefit even after making your hedging points and various adjustments. that premium is pretty much your window of opportunity, and there are specific hedging points that make it ideal to preserve that premium. it's not as simple as just delta hedging at every half point because stuff like your gamma/theta ratio changes everyday. of course, these inefficiencies won't guarantee that you will profit, but what you should have is a greater probability of making than losing money over time. it's not neutral expectancy when the markets aren't even efficient! so how do you locate these inefficiencies? well, you need a very good understanding of volatility of options, but going into that is like opening a whole can of snakes, bugs, and worms....
i wrote my own software. you want me to disclose everything to everyone that i don't even know? i gave out some general principles. i think that's enough for now.
i don't think anyone who holds that markets are efficient claims that inefficiencies do not creep in every once and a while. the basic point about zero-expectancy though is that the markets are close enough to efficient - so close that an average moe hasn't got the resources to ferret out inefficiency and profit from it - that assuming efficiency is a sound and prudent practice. it doesn't take a statistics phd to see that implied volatilties do not correlate 100% with future volatilities and that volatility skews do not correlate 100% with actual probabilities. but the odd thing is that these measures - implied volatility and skew - do a pretty good job of predicting the future. yes they are frequently wrong but there is no proven way of knowing if these market estimates of future events are too high or too low. you claim to have found such a method that identifies the market's errors. i and i'm sure a few others would be more than happy to look into that can of "snakes, bugs and worms" in some detail. until you can offer some kind of evidence for your claim, i can't see how anyone could take you seriously.
i would concede your point if studies could be found to support similar excess returns by put sellers (or for that matter any option strategy long or short). i'm not aware of any and i can't believe that after 20 years in this business i hadn't come across such claims. but what the heck, i still learn something new trading nearly every week. so if you have some cites i'd love to see them.
Great post Mike. I am in complete agreement with you. But let's play along here for a second. Let's assume we have two possibilities here. Either one, markets are pretty efficient like you, me and riskarb agree, and that any opportunities to capture these slight inefficiencies are very short lived and the resources it takes to find them are substantial, or two, Anseld is right and option prices are quite inefficient and opportunities are present to take advantage of them. Let's assume the latter is true for arguments sake. Here is where Anseld's argument completely falls apart (big surprise). He is assuming that all the pricing inefficiencies are in his favor! In other words, let's assume the implied vols for GOOG are substantially overpriced and appear to be presenting an opportunity to sell them. How does Anseld not know, that these options are in fact UNDERPRICED! According to his own words, he is claiming that they are inefficient. That could mean they are being underpriced or overpriced. How the f*ck does he know before the fact? He doesn't. And vice versa with cheap options. you might have options trading at historical lows that appear to be presenting an opportunity to buy them when in fact, those options, as cheap as they are, are actually UNDERPRICED! Again, if he makes the argument that prices are not efficient, he can't have his cake and eat it too and assume they are only inefficient in the direction he thinks they are. A perfect example of this last year was in the biotechs. There were over a dozen FDA plays last year where vols were trading at all time highs well into the 300's. When in reality, those options turned out to be substantially underpriced. So he can't have it both ways. Either the markets are efficient or close enough. Or they are not efficient but we have no way of knowing if the prices are actually overpriced or underpriced. We might believe they are overpriced because on paper, they look so high. But the reality is, there is no way of knowing this until after the fact. If markets can error on the side of making options too rich, then certainly they can error on the side of making them too cheap. Either way, Anseld's argument holds no water.