Watch HowardCohodas Trade Index Options Credit Spreads

[meanreversion]

Thus the majority of volume is devoted to uses other than spreads. This leaves a nice niche for me to exploit.

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.

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.

I'll be honest, I don't believe you have an edge. But then most people don't!

Let's just go through some of these comments - "leaves a nice niche for me to exploit". This doesn't mean anything, sorry. You either believe that implied vol is rich more often than not, or you don't.

You think your edge comes from the way you manage the spreads.. well, possibly, if you had many years trading them, I might buy that. But you don't, and you certainly don't have inside information (this is a very common edge for hedge funds).

I know that you do appreciate these comments as I can see you've thought about them quite hard. But I would suggest that if you're not sure what your edge is, then you don't have one.

I trade a trend model. I believe my edge is that (aside from the very extensive backtesting I've done, including some relatively advanced money management rules) it is a style of trading that most people don't like. It has a low win rate, volatile p/l and low frequency of trading. My edge is that I know from experience that most people are poor traders (this is not condescending, it's a fact) and that cognitive biases prevent profitable trading, thus I trade systematically in a fashion that would be anathema to most people. It's a style of trading that's as old as the hills, but doesn't sit well with traders/investors who like to earn 5% a month with no deviation (the "Holy Grail").

Ok, I think you need to go back to the drawing board a little. Read up some more about options, and work out what you really believe is your edge.

Here's a little option tester for you - when volatility rises, what happens to the gamma of an option?

 

[HowardCohodas]

Ok, I think you need to go back to the drawing board a little. Read up some more about options, and work out what you really believe is your edge.

I trade scared every day. Just like I fly scared when I'm the pilot in command. I'm always looking for what I've missed that will come back to bite me.

I respect your experience and wisdom in trading. How would you account for my results in nearly 19 weeks of trading? Was this market just happily conducive to my methods? Am I just extraordinarily lucky and my luck will change? Or what?

For reference, as of two days ago my results are summarized here.

 

[meanreversion]

What kind of win rate did you get in testing, around 90%?

 

[bs2167]

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?

This ignorance comment made me feel like I'm on candid camera. Most ironic thing that I've read in a long time, maybe ever. If only you could be so lucky that your trades were only with a single person, at least that way you'd have a chance to find a sucker who misprices them. Instead, you are trading against the collective opinion of the entire options market. What are the odds they're all wrong and you're right?

I know you believe that mispricings are possible because of demand/supply imbalances. But if that were the case don't you think that a big hedge fund or I-bank with the ability to shoulder large pnl volatiltiy would step in and put your trades on until the mispricing were driven down to zero? You don't seem willing to acknowledge that options pricing is based on an arbitrage-free efficient market.

Let's assume for a moment the HFs and IBs choose to leave this money on the table and mispricings actually exist for you to take advantage of. Do you think they would be large enough to overcome the bid/ask spread and commissions? Furthermore, do you think they be large enough to overcome bid/ask, comm, and also conveniently be available to you at the end of EVERY month just when you're ready to roll positions?

Step back and objectively ask yourself what the odds are of the answers to these questions being in your favor. Without any one of them, you have no edge.

I tried to think of different ways to express my point without getting technical, but based on your responses I don't think I've done a very good job of it. Unfortunately, I'm tapped out. I do agree with everything that MR has said, so if the way he's laid it out makes more sense to you, great. He and I have similar backgrounds, so its not surprising at all that we're on the same page when it comes to evaluating your strategy.

-----

Also, don't see the edge you claim in your description of adjusting your trades. Without bonafide skill or a significant statistical tendency by which you sytematically make your adjustments, you will be right with some adjustments and wrong with others...net, net zero edge but more expenses, further increasing the size of your negative expectation.

I promise that if you go through the reading material i posted earlier, you won't regret it.

 

[HowardCohodas]

What kind of win rate did you get in testing, around 90%?

Yes, give or take a percent or three over the five years of data I used. However, I counted all sides of an iron condor (when formed and including rolls) as a win if the net was a win. This probably is not common practice, but it seemed practical to me.

 

[meanreversion]

Yes, give or take a percent or three over the five years of data I used. However, I counted all sides of an iron condor (when formed and including rolls) as a win if the net was a win. This probably is not common practice, but it seemed practical to me.

With a win rate like that, you'd expect pretty much every month to be up money, so your very limited results so far seem par for the course I would think.

 

[meanreversion]

I promise that if you go through the reading material i posted earlier, you won't regret it.

I do believe Howard is now thinking very hard about what you've said, it wasn't in vain.

 

[HowardCohodas]

We seem to be talking past each other rather than to each other, but I am willing to continue trying to communicate successfully as I know you have.

Instead, you are trading against the collective opinion of the entire options market. What are the odds they're all wrong and you're right?

I know you believe that mispricings are possible because of demand/supply imbalances. But if that were the case don't you think that a big hedge fund or I-bank with the ability to shoulder large pnl volatiltiy would step in and put your trades on until the mispricing were driven down to zero? You don't seem willing to acknowledge that options pricing is based on an arbitrage-free efficient market.

Regarding mis-pricing not being a viable strategy, we are in violent agreement.

However, mis-pricing does not, Not, NOT, have anything to do with my methods. I simply use to my advantage the pricing established by the predominant market uses of options.

Also, don't see the edge you claim in your description of adjusting your trades. Without bonafide skill or a significant statistical tendency by which you sytematically make your adjustments, you will be right with some adjustments and wrong with others...net, net zero edge but more expenses, further increasing the size of your negative expectation.

My management strategy is actually quite simple. It started out more complex, but I continue to simplify when I find rules that do not provide any benefit. If a spread has developed 80% or more of their potential AND there is a spread available that meets my criteria (the same as initial entry) then I attempt a roll. On some occasions, by the time I buy back the spread, the spread I intended to replace it with no longer fits my criteria.

I promise that if you go through the reading material i posted earlier, you won't regret it.

All three are on my reading list. You added one. Thanks.

 

[HowardCohodas]

With a win rate like that, you'd expect pretty much every month to be up money, so your very limited results so far seem par for the course I would think.

I'll accept that. However it still begs the question of how do I get that kind of win rate? You maintain I do not have an edge. I cannot effective describe my edge. So how is this result possible without an edge, describable or not?

 

[HowardCohodas]

I do believe Howard is now thinking very hard about what you've said, it wasn't in vain.

You must be able to smell the smoke all the way across the pond.

 

[meanreversion]

Howard, you need to answer these simple questions.

1. Do you believe that implied vol is usually rich, i.e. options are generally too expensive?
2. Do you believe that you have found a method to calculate probability which is not only different from that implied by the options market, it is more likely to be correct? In other words, options are not correctly valued for the most part?

There's nothing else I'm afraid. Simply because you trade condors and have a technique for getting in and out doesn't mean you can duck these two questions.

 

[meanreversion]

I'll accept that. However it still begs the question of how do I get that kind of win rate? You maintain I do not have an edge. I cannot effective describe my edge. So how is this result possible without an edge, describable or not?

Pretty easy. Imagine a simple trading system which has a take profit 10 pips away and a stop loss 200 pips away.. it will have a 90%+ win rate..

 

[HowardCohodas]

Howard, you need to answer these simple questions.

1. Do you believe that implied vol is usually rich, i.e. options are generally too expensive?

No

2. Do you believe that you have found a method to calculate probability which is not only different from that implied by the options market, it is more likely to be correct? In other words, options are not correctly valued for the most part?

No

There's nothing else I'm afraid. Simply because you trade condors and have a technique for getting in and out doesn't mean you can duck these two questions.

Were I naked trading, I would find your questions and conclusion much more compelling. However I am selling credit spreads. Thus, at a given probability of touching, the options price differences between strikes expand and contract with volatility. But, then also does the estimate of the probability of touching. This combination exposes opportunities for superior credit available at a given probability of touching. I don't have the math to demonstrate this analytically. It is however, an easy observation to make.

 

[bs2167]

However, mis-pricing does not, Not, NOT, have anything to do with my methods. I simply use to my advantage the pricing established by the predominant market uses of options.

This is at the core of the problem...without mis-pricing you cannot have positive expectation. This is an undeniable fact, you just don't see it yet. There is no spread combination that allows you to escape it. Two fairly priced options combined into a spread just give you a fairly priced spread - still no positive expectation.

In the same vein, you cannot answer "no" to MR's questions and claim to have an edge. Impossible. Btw, your strategy implies that your answers are "yes" despite you saying "no".

 

[meanreversion]

Yup. If you believe the options market is efficient and fairly priced, you cannot expect to make money in the long run by systematically being short gamma in order to "earn" time decay. It doesn't matter how you dress it up, you have no edge.

You could sail along making money for a year without too much stress and then one day the market will turn around and bite you. It's inevitable I'm afraid. (Un)fortunately you haven't traded this instrument long enough to be burned yet.

I would go perhaps a little further and suggest that your system has blatant negative expectancy. You're crossing several bid/ask spreads to put on these condors, and in addition you'll pay a decent whack of commission.

Now, you MUST go back to square one and find your edge. At the moment you might be able to convince your wife you have an edge, but she's probably a receptive audience. You need to do a better job of convincing the cynics on t2w!

 

[meanreversion]

Were I naked trading, I would find your questions and conclusion much more compelling. However I am selling credit spreads.

You're selling options, right? Thus you are short gamma, i.e. your delta will always change in an unfavourable fashion as the underlying moves around.

Now, page 1 of the options handbook describes put call parity. Buy a call and sell a put with the same strike and expiry, and you are equivalently long of the outright forward, +C-P = +F

Using this formula, a "covered call", for example is +F-C, which equals -P. Hey presto - a covered call is in fact a naked short put!

It doesn't matter what you call it, the point is you are short gamma (people will insist on deluding themselves in thinking that covered calls are somehow riskless). Thus you will "earn" time decay, but for decent moves in spot, your delta will change adversely. There are no two ways about it.

 

[meanreversion]

(Did you have a think about my options question - take a 25 delta option, for example.. what happens to the gamma of the option as the volatility increases?)

 

[HowardCohodas]

(Did you have a think about my options question - take a 25 delta option, for example.. what happens to the gamma of the option as the volatility increases?)

I'm temporarily avoiding answering this question for reasons which I hope will become understandable shortly.

Meanwhile, riddle me this... Of the 52 spreads I have established since I opened the account I report on, 20 remain open. And their net gamma is -6. How does that fit into your model of what I am doing wrong?

 

[scose-no-doubt]

Howard where can I find posts on how you pick the strikes you trade your ICs

 

[HowardCohodas]

Howard where can I find posts on how you pick the strikes you trade your ICs

Rather than look for it, I'll just list them here.

I target a 5% average for each side of an Iron Condor. For an option series with a $10 difference in strike price, that's $.50. Since the markets are not symmetrical with respect of PUT spreads and CALL spreads, that may mean $.70 on one side and $.30 on the other. I am unlikely to go below $.30 credit for completing the Iron Condor because it does add some risk even though no additional margin is required. Therefore, my target is a 10% return for an Iron Condor.

The other critical rule is the Probability of Touching limit. This is primarily determined by the traders level of risk tolerance. I personally, would never go over 25%, but others might. I started out at the low end (around 10%) and worked my way up slowly until I got uncomfortable. I then backed off a notch.