I've read most of your pertinent posts, so I think I understand what you're doing. I know you've backtested etc. but I still can't deduce your edge. I think it has to be one of three possibilities -
1. You've found a way of evaluating probabilities which is not reflected in option prices (this simply can't be true)
2. There is an element of trend following in your system (is this right?)
3. You have a strong feel for the market and place trades in a discretionary manner, and are able to do this successfully because of your experience (although this is not something you could have backtested, so I'm not sure this is the answer either).
Any thoughts on this?
Your post arrived with perfect timing as I was just about to address my understanding of my edge in response to other parts of your previous post.
First, the frightening part. I am completely agnostic regarding view of market direction.
Second, there is a part of trend following in the way I manage the spreads, but not in their setup. Thus a trending market usually makes me considerably more money than a sideways market. In a trending market, I may roll one side or the other or sometimes both sides of an iron condor a number of times before expiration. In a strongly trending market, I may be forced to abandon one side of the iron condor. So far, a strongly trending market is what I perceive to be my most serious risk element. Therefore, I choose my bail-out point carefully so that I don't wipe out months of profit. I have not yet encountered a market that trended so strongly that I had to take my maximum loss (as opposed to the maximum loss implied by the spread). However in testing, so many roll opportunities presented themselves on the other side of the iron condor, that in most cases the iron condor was still profitable in spite of taking a 20% to 30% (or capital at risk) hit on the losing side.
So, other than exploiting trending, where does my edge come from? My study of options and their uses leads me to believe that there are a huge number of uses too which professional and retail traders put them. And not all uses drive the prices in the same direction. There is a natural tension among their different uses that brings relative order to the market. There have been times that particular uses have driven volatility to extremes, but this appears to be unusual.
Thus the majority of volume is devoted to uses other than spreads. This leaves a nice niche for me to exploit. There are those who ask why would anyone in their right mind take the opposite side of my trade. I think that question displays some ignorance of the options market. It assumes that when I sell a credit spread, both legs are traded with the same person. Why would that be true?
My conclusion is that my edge comes from the way I manage my spreads (and iron condors) and the credits available as a result of the preponderance of option trading not devoted to taking the opposite sides of my spreads.
So have I found the holy grail, or am I in for a huge fall as some here have predicted, or something in between. We'll see.
As long as there is interest in this thread, I will endeavor to continue posting to it, including my screw-ups. I'm unsure what my time availability will be if/when I go through with my ETC program.
BTW, I truly appreciate those that take the time to challenge my assumptions and my methods. Answering the questions has caused me to think much more deeply than I had thought when I started. I think you guys have made me better at what I do.
