Watch HowardCohodas Trade Index Options Credit Spreads

[meanreversion]

Why do options have to overpriced for the spread to offer a yield of 5% for 60 days. Connect the dots for me.

Because, to this point, you've not experienced life around a short strike. The markets have been calmly drifting higher, which is a perfect scenario for you.

The Black Scholes formula incorporates the "risk free" interest rate for the relevant period, and this rate is used to discount the premium of the option (it's paid up front). If you price up a 100 year option, you'll see it's incredibly cheap, but it's because of discounting.

Anyhow, this "risk free rate" is certainly not 5% for 60 days.

Thus, in order to earn this (which is what you have done so far), you have to be selling something else. Because if you weren't, it would violate the principle that options are (more or less) fairly valued, which you claim to accept. Even if they're a little bit overpriced, it does not equate to an annualized rate of return of 30%.

So, what are you selling?

 

[HowardCohodas]

Well, when these spreads are entered I would imagine they are delta neutral.

No they're not. Not until the spread is paired with it's mate to form an Iron Condor.

But the system is short gamma, so the delta will always change adversely when spot moves.

No it's not. It is nearly neutral gamma with only a slight negative tilt.

As the short strike nears expiry, the short gamma will start to increase.

Not that I can detect. The data is to noisy.

The premium of an option is the expected cost of hedging it. So, if the strategy is consistently short gamma, then over time you would expect the time decay earned to be exactly offset by the cost of delta hedging the positions.

Depends on the above being true, but it isn't.

It doesn't really matter whether you sell ATM straddles, or low delta strangles, or condors.. the principle is always the same. The only way this strategy can work in the long run is if options are systematically overvalued.

Why?

Howard, what you should start doing is looking at historical vol vs implied vol. This is akin to comparing apples to pears, but it will give you an idea of when implieds are very high/low relative to historicals. Having said that, when this divergence occurs, it's usually for a reason (e.g. big event coming up, holidays, more option buyers than sellers) so it's only a rough guide.

That might help me better understand the points you are making that don't seem to be sinking in.

 

[HowardCohodas]

Because, to this point, you've not experienced life around a short strike. The markets have been calmly drifting higher, which is a perfect scenario for you.

The Black Scholes formula incorporates the "risk free" interest rate for the relevant period, and this rate is used to discount the premium of the option (it's paid up front). If you price up a 100 year option, you'll see it's incredibly cheap, but it's because of discounting.

Anyhow, this "risk free rate" is certainly not 5% for 60 days.

Thus, in order to earn this (which is what you have done so far), you have to be selling something else. Because if you weren't, it would violate the principle that options are (more or less) fairly valued, which you claim to accept. Even if they're a little bit overpriced, it does not equate to an annualized rate of return of 30%.

That's the best explanation of the option's mechanisms so far in this thread. Thanks.

So, what are you selling?

??????

 

[meanreversion]

Depends on the above being true, but it isn't.

I hate to say it, but once again you're revealing that you think options are mis-priced.

If the premium of an option is not the expected cost of hedging it, what is it?

 

[meanreversion]

That's the best explanation of the option's mechanisms so far in this thread. Thanks.



??????

Ok, you're just being dense now.

You are "earning" 30% a year, by your figures, so either

a) options are totally mispriced or
b) you're selling something, either gamma or skew

The market isn't going to pay you 30% a year for nothing, not when 1yr rates are about 1%.

What risk are you taking on, in order that the market is compensating you in this fashion??????

 

[HowardCohodas]

Howard - can you explain is a short paragraph the essence of why you're method has positive expectation instead of referring back to links and other posts? I'm really struggling to understand how you're doing this and I don't think I'm alone either. Is it mispricing? Is it directional? Is it something else?

If the Probability of Touching is a fair estimate of my taking some kind of loss, then post #172 is a good representation of expectation.

The highlighted portion illustrates the 1875/1850 spread where the short option has a probability of touching of 15% for a credit of $1.75 for a potential profit of 7.5% at expiration. I will treat the probability of touching as a proxy for the chances that the I will not let the option expire at zero and earn maximum return. Then I compute the mathematical expectation of this position as 85% chance of earning 7.5% return and a 15% chance of losing 15%. This yields a mathematical expectation of 4% return.

 

[HowardCohodas]

Ok, you're just being dense now.

You are "earning" 30% a year, by your figures, so either

a) options are totally mispriced or
b) you're selling something, either gamma or skew

The market isn't going to pay you 30% a year for nothing, not when 1yr rates are about 1%.

What risk are you taking on, in order that the market is compensating you in this fashion??????

Not to be overly pedantic, but how do you get from 8% to 12% a month to 30% per year.

 

[MrGecko]

Some reasoning behind that would be helpful in converting competing monologues to a dialog.

All you are doing is exchaning an option for it's equivalent value in Dollars. Again and again and again. The only way you can make money like this is if one side of the equation is unbalanced.

Where did you learn about options Howard? Because when MR says

The premium of an option is the expected cost of hedging it. So, if the strategy is consistently short gamma, then over time you would expect the time decay earned to be exactly offset by the cost of delta hedging the positions.

and you say

Depends on the above being true, but it isn't.

I worry about the people who have given you money to manage!

 

[HowardCohodas]

I hate to say it, but once again you're revealing that you think options are mis-priced.

If the premium of an option is not the expected cost of hedging it, what is it?

In order to conclude that options are overpriced for this to work, I would have to postulate that they are perpetually so.

Where does that leave me?

 

[scose-no-doubt]

Well, when these spreads are entered I would imagine they are delta neutral. But the system is short gamma, so the delta will always change adversely when spot moves. As the short strike nears expiry, the short gamma will start to increase.

Thats what I'm saying... I don't understand how losses can be capped @ say 15% or whatever... how would you know how much you're getting back?

 

[meanreversion]

Why do options have to overpriced for the spread to offer a yield of 5% for 60 days. Connect the dots for me.

5% for 60 days, is this not roughly equivalent to 30% a year?

But please be pedantic, as it prevents you from answering the real question, which is - what are you selling, gamma or skew?

 

[scose-no-doubt]

That's the best explanation of the option's mechanisms so far in this thread. Thanks.



??????

WTF? I told you that a week ago! Or implied anyway.

 

[HowardCohodas]

All you are doing is exchaning an option for it's equivalent value in Dollars. Again and again and again. The only way you can make money like this is if one side of the equation is unbalanced.

Where did you learn about options Howard? Because when MR says


and you say


I worry about the people who have given you money to manage!

Careless editing of my post changes the meaning. That is unfortunate. It was careless and not purposeful, right?

I've stated numerous times why I do not, and will not manage other people's money. Again, that's an unfortunate statement that implies the opposite of what I have stated repeatedly.

These are not very good methods of making your point.

 

[robster970]

Thanks Howard. All this tells me though is that you are relying on a capped loss to create a +ve expectation. This isn't the case as I understand it. Is this the flaw?

 

[HowardCohodas]

WTF? I told you that a week ago! Or implied anyway.

Being generous to one hurt another. My bad.

 

[HowardCohodas]

Thanks Howard. All this tells me though is that you are relying on a capped loss to create a +ve expectation. This isn't the case as I understand it. Is this the flaw?

Other than a shock market, why is this an unreasonable assumption? Is not all investment analysis based on managing the losses? If I buy any trading instrument, I don't assume that the failure of my investment will be a zero value. I would be expected to bail out before that.

Why is this any different?

 

[MrGecko]

Careless editing of my post changes the meaning. That is unfortunate. It was careless and not purposeful, right?

I've stated numerous times why I do not, and will not manage other people's money. Again, that's an unfortunate statement that implies the opposite of what I have stated repeatedly.

These are not very good methods of making your point.

In part; apologies if you do not manage other peoples money, I was under the impression that you were trading for, or advising, some of you family members, and that you intend to start an options advisory service.

However, the rest of it is pretty much on the money.

The Point, Howard, is that you don't make money without taking risks, and you don't understand the risks that accompany the money you have been making.

 

[HowardCohodas]

5% for 60 days, is this not roughly equivalent to 30% a year?

5% for 60 days on each half of the Iron Condor. The second half requires no additional margin.

But please be pedantic, as it prevents you from answering the real question, which is - what are you selling, gamma or skew?

What prevents me from answering your questions in your frame of reference is the same thing that prevents you from understanding my explanations in my frame of reference. Until one of us sufficiently educates ourselves in the other's frame of reference, this will likely remain the case.

 

[meanreversion]

5% for 60 days on each half of the Iron Condor. The second half requires no additional margin.



What prevents me from answering your questions in your frame of reference is the same thing that prevents you from understanding my explanations in my frame of reference. Until one of us sufficiently educates ourselves in the other's frame of reference, this will likely remain the case.

I really fail to see how I could be any clearer.

You're achieving 30-60% a year, whatever it is, you tell me.

Why is the market prepared to give this to you? What risks are you taking on in order to earn this amazing return?

The reason you can't answer the question is because you simply don't know.

 

[HowardCohodas]

In part; apologies if you do not manage other peoples money, I was under the impression that you were trading for, or advising, some of you family members, and that you intend to start an options advisory service.

However, the rest of it is pretty much on the money.

The Point, Howard, is that you don't make money without taking risks, and you don't understand the risks that accompany the money you have been making.

I do plan to teach my methods, so you are partially correct. No advisory service. No managing other peoples money. Just education, training and coaching (ETC).

You completely reversed my point by your editing, so I don't agree it is on the money. I said that if the premises were wrong, which I showed, then the conclusion was not proved. Not proved and wrong are quite different ideas.

It is not required to have a complete understanding of risks in order to manage them. Otherwise why would most people to take any mechanical means of transportation?

I believe I have show a pretty powerful method of managing the several risks involved with my methods. I believe that that is quite sufficient to be successful. You do not. Such is life.

I just don't see the your're right, I'm wrong dichotomy presented here.