Best Thread The Options edge (Writing Vs Buying)

[andycan]

There are a few important points on the link provided by Zupcon that are not mentioned in the report by Guy Bower.
I was wondering if any members here has spotted what is missing? it is fairly rudimentary.
I suspect CYOF and Socrates would have spotted it. maybe other members here know but have not mentioned anything just curious!

 

[Splitlink]

Common Sense Question No.1

What is the most important thing to understand, in relation to trading Commodity & Index Options, for consistent profits?

Now, this question is not a trick question, It is but a simple common sense question, that is based on my study of Options to date, and from a logical deduction, been backed up by market data from the various exchanges, proves to be a question well suited to the desired outcome, the desired outcome been, consistent profits when trading Commodity & Index Options.

I haven't traded options for a long time, so am quite rusty and may not be the most reliable source of knowledge. However, I am willing to stick my neck out in the hope that more experienced option traders will rejoin the thread.

I believe that the most important point to understand, with option trading, is that one must ask oneself what the time value is and in what periods, if one is to be a buyer, is there the most time decay. The maximum decay area, is probably around 7-8 months right down to the last few days before expiry, but that would need checking out-- don't take my word as gospel. A rising share price, during this period, will not help a call buyer-- I can tell you that much from experience, and I can't see much point in trying. Regardless of the fact that there are many who may disagree with me, writers have the advantage because of the time decay, providing that they stay within the limits that I mentioned.

If anyone buys a long term option and the share does not move before the time decay begins to become apparent--- SELL before the wastage gets you!

I found, at that time, that the problem with far out options is the cost. They are dear and I could not afford to buy many. Probably, the close ones are the best but, believe me, you can get caught badly on those unless you are within a couple of days of expiry.

Now that I am old and grey, the most conservative course for me, apart from leaving them alone, would be writing covered options on shares that I own.

Index options are another thing. They require spreads for protection and I lump them together with all index trading---risky.

Split

 

[Splitlink]

It's a continutation from your stories so makes no sense on it's own - hence have merged in with the thread now residing in the Psychology forum. CYOF - please continue to post on that thread - as we want to keep things on topic and flowing on this thread, and not have to continually move things across.

Crikey, Sharkey!!!! That cost me -----get mine back here!!!!

Split

 

[zupcon]

There are a few important points on the link provided by Zupcon that are not mentioned in the report by Guy Bower.
I was wondering if any members here has spotted what is missing? it is fairly rudimentary.
I suspect CYOF and Socrates would have spotted it. maybe other members here know but have not mentioned anything just curious!

Yes there are a couple of things missing in the report by Guy Bower, however, I think that that report is more concerned with pointing out the obvious inconsistencies in the John Summa report, which I think he does reasonably well.

What is interesting is that if you read John Summa's book (and Ive only had an oportunity to briefly skim through sections) he once again quite clearly states that writers have the edge over buyers. HOWEVER in the book the main thrust of the argument as to why this is the case is somewhat different (and in my opinion at least more accurate).

He claims that the majority of buyers are relatively inexperienced traders, he claims that the motivation of the buyers isn't necessarily speculative, he claims that the sellers are generally more experienced traders, and generally better funded. More importantly he claims that the principal reason for the writers edge is access to better pricing models. He also argues very superficially that the writer has an edge due to theta time decay (but completely fails to mention the inverse argument with respect to gamma), there might also be a bit about leprachauns somewhere but I havnt seen it yet.

As I say, I havn't read the book in its entirety, so its a little unfair to draw definitive conclusions at this stage, but the material presented in the book does seam to paint a very different picture.

regards
zup

 

[Hook Shot]

Index options are another thing. They require spreads for protection and I lump them together with all index trading---risky.

Split

Lumping them together would seem to be a good hedging strategy....
If "froth" inherent in options .... say puts is a wasting "asset" the using futures as a hedge may be but one way of .. catching the desired move ........ perhaps ?


Second Thoughts - my strategy makes things overly complicated .......

 

[Sharky]

Splitlink - you must have replied to the post and not the thread - hence your reply on that thread and not this one. Anway have moved it back here along with CYOF's orginal question so it makes sense.

 

[Splitlink]

Splitlink - you must have replied to the post and not the thread - hence your reply on that thread and not this one. Anway have moved it back here along with CYOF's orginal question so it makes sense.

Thanks, I was trying to be friendly to the guy, so tried to answer his question.

Split

 

[Splitlink]

Lumping them together would seem to be a good hedging strategy....
If "froth" inherent in options .... say puts is a wasting "asset" the using futures as a hedge may be but one way of .. catching the desired move ........ perhaps ?

More experienced people would need to answer that. My opinion , for what it is worth, is that the more hedges, straddles, etc that you do, the more expensive everything gets. In the end, you protect yourself so much that you can't make anything. Towards the end, I bought straight calls with 9 month expiries with no calendar spread involved. I made good interest on my money, because I got the share direction right.and got out before decay set in.But I should have been writing, that was where my mistake lay.

I think that options should be taken in context. They are meant to protect holders of shares, those who don't want to sell and wish to take advantage of any setbacks.

Anything else are, really, gimmicks invented by the moneymakers to get money out of the unsuspecting. They make everything seem so easy and most of the encouragement, if you notice, is aimed towards the potential buyer, with the argument of limited loss and unlimited gains. I know that that is true but, what they don't tell, is that you lose more often than you win.

Split

 

[CYOF]

I haven't traded options for a long time, so am quite rusty and may not be the most reliable source of knowledge. However, I am willing to stick my neck out in the hope that more experienced option traders will rejoin the thread.

I believe that the most important point to understand, with option trading, is that one must ask oneself what the time value is and in what periods, if one is to be a buyer, is there the most time decay. The maximum decay area, is probably around 7-8 months right down to the last few days before expiry, but that would need checking out-- don't take my word as gospel. A rising share price, during this period, will not help a call buyer-- I can tell you that much from experience, and I can't see much point in trying. Regardless of the fact that there are many who may disagree with me, writers have the advantage because of the time decay, providing that they stay within the limits that I mentioned.

If anyone buys a long term option and the share does not move before the time decay begins to become apparent--- SELL before the wastage gets you!

I found, at that time, that the problem with far out options is the cost. They are dear and I could not afford to buy many. Probably, the close ones are the best but, believe me, you can get caught badly on those unless you are within a couple of days of expiry.

Now that I am old and grey, the most conservative course for me, apart from leaving them alone, would be writing covered options on shares that I own.

Index options are another thing. They require spreads for protection and I lump them together with all index trading---risky.

Split

Firstly, thank you for getting my post back, you must have magical powers like my little friend LouDean

Now, why do you think that Index trading is very risky?

Is it because you have experience with this type of trading, or is it because of you own opinion based on what you have seen and heard - in other words, your Inspiration?

 

[Profitaker]

He claims that the majority of buyers are relatively inexperienced traders, he claims that the motivation of the buyers isn't necessarily speculative, he claims that the sellers are generally more experienced traders, and generally better funded. More importantly he claims that the principal reason for the writers edge is access to better pricing models.

I'd agree with that sterotype. I would also point out that the writer is subject to stringent (and complex) margin requirements which limit his ability to do daft writes. The buyer however, is free to blow his account and nobody cares. Whether that is an "edge" or would be better described as forced discipline, I think the latter.

Not sure how anybody would define a "better model", because they are mainly derivatives of the tried and trusted BS model, and in any event a quick google will give the buyer guts of just about any model.

 

[andycan]

Yes there are a couple of things missing in the report by Guy Bower, however, I think that that report is more concerned with pointing out the obvious inconsistencies in the John Summa report, which I think he does reasonably well.

What is interesting is that if you read John Summa's book (and Ive only had an oportunity to briefly skim through sections) he once again quite clearly states that writers have the edge over buyers. HOWEVER in the book the main thrust of the argument as to why this is the case is somewhat different (and in my opinion at least more accurate).

He claims that the majority of buyers are relatively inexperienced traders, he claims that the motivation of the buyers isn't necessarily speculative, he claims that the sellers are generally more experienced traders, and generally better funded. More importantly he claims that the principal reason for the writers edge is access to better pricing models. He also argues very superficially that the writer has an edge due to theta time decay (but completely fails to mention the inverse argument with respect to gamma), there might also be a bit about leprachauns somewhere but I havnt seen it yet.

As I say, I havn't read the book in its entirety, so its a little unfair to draw definitive conclusions at this stage, but the material presented in the book does seam to paint a very different picture.

regards
zup

Now now no digging, we all know that leprechauns know where the pot of gold is
and yes you pointed out one of the facts that i was refering to but there are others. ok lets consider your points on option traders,logic would state that less experienced options players would be attracted to buying option
looking at it from a simplistic point of view limited risk with unlimited gains is a potential pot of gold to the newbie or to be fair less funded and less experienced traders of options, on the other hand from a newbie point of view the concept of writing would be considered daunting
limited gains unlimited risk not so attractive.
but again for the less experienced lets consider what the underlying does, i know many here use 'greeks' to evaluate a position. so lets assume a buyer buys a call or put
the market will do one of four things, in this case from the perspective of entry point
1/ the market will go to the strike price and beyond to give the buyer a profit - so buyer wins
2/ the market will go in the correct direction buy not enough to compensate the cost of initial premium in effect - buyer losses
3/ the market will go completely the opposite direction to expect direction - buyer losses
4/ the market will be sideways or where it was at the point of buying - buyer losses

so taking this to be a fact which it is (from the underlying action not stratergy used in options) the only variable is your entry and your strike.
the buyer has 1 in 4 chance in winning whilst the writer has 3 out of 4 chance of winning
lets not forget there are buyers out there that make a mint out of speculative options buying the ones i know that can do this can make fortunes in buying as well as writing but this thread is not about who can make more money out of writing or buying this is a simple case of who has the advantage or the edge. based on what the underlying does the writter in my opinion always has

 

[Profitaker]

Andy

You need to consider the extreme moves that the market sometimes makes, up as well as down. If these moves are 3 times the normal size, then the profits a buyer generates in scenario 1) would make up for the losses gerenerated in scenarios 2), 3), and 4).

Simplistic I know, but do you see my point ?

 

[ducati998]

andycan

The topic of the thread asks;
The "edge" does it lie with the sellers [writers] or buyers?
In this context, the skill set of the individual trader is irrelevant, as it is the strategy that is being examined, not the trader.

In regards to your assertions;

1/ the market will go to the strike price and beyond to give the buyer a profit - so buyer wins
2/ the market will go in the correct direction buy not enough to compensate the cost of initial premium in effect - buyer losses
3/ the market will go completely the opposite direction to expect direction - buyer losses
4/ the market will be sideways or where it was at the point of buying - buyer losses

Incorrect.
You seem to have confused the underlying with Options.

#2 & #4
If the Option is purchased at a low IV value, and price stays below strike, but IV is revalued higher, buyer can win and sell at a profit.

So, in effect, both the buyer and seller can win in three out of four scenarios, thus their *edges* are equal, which is the question the thread seeks to answer.

jog on
d998

 

[andycan]

Andy

You need to consider the extreme moves that the market sometimes makes, up as well as down. If these moves are 3 times the normal size, then the profits a buyer generates in scenario 1) would make up for the losses gerenerated in scenarios 2), 3), and 4).

Simplistic I know, but do you see my point ?

Profitaker
indeed i do
i know this for a fact that extreem moves distorts pricing and to the expert he can buy all day long and the market not move much and is in profit once the dust has settled.this i have done many times in the grains under the expert guidence of a very experienced options trader once we had determind the low or high. we also determind the fast move so we knew in advance it was going to happen now thats not something you here to often.
the only problem with these fast moves is. what created the moves in the first place?
is it a parabolic is it covering is it panic, is it the end of the trend, clues in the market tell you which one it is and like horses for courses you plan and execute
indeed the writer could be caught with his pants down but i suspect an expert may take it on the chin but never wipe him out or has provisions in place in the event of a catastrophe
but i still have to conclude under normal circumstances the writer has the edge

 

[garethb]

the buyer has 1 in 4 chance in winning whilst the writer has 3 out of 4 chance of winning

A person can walk into a casino and put £1000 on each of 35 of the 36 numbers. He has 35 chances out of 37 of winning and walking away with £1000 profit. The casino only has 2 chances out of 37 of winning.

Higher likelihood of a win does not make an edge

 

[Profitaker]

Exactly Grant

So who has the edge in the casino ?

 

[Profitaker]

Perhaps the confusion over writer / buyer edge boils down to the difference between frequency of profits and magnitude of profits. Grant has given a simple yet excellent example of this.

Nobody would argue (well perhaps some here would argue just for the sake of arguing) that the casino has the edge. Yet despite this, using the strategy that Grant has put forward, the casino loses not 1 in 4 times, but 35 out of 37 times ! How can it be that the casino has the edge and makes good profits over the long run.

The answer is that although the gambler wins many frequent lots of £ 1000, when the casino wins the magnitude of the win is massive (£ 35,000) and wipes out all the gamblers gains, and then some.

This principle is exactly the same when laying a 20/1 horse not to win a race, or selling a 0.10 delta Put option.

The edge lies in determining the true odds of any probability. Simple, but in the case of options complex odds calculations are needed.

 

[ducati998]

et al

If I were to purchase a Deep in the Money Call, then the probabilities of the Call expiring ITM would be very high.

Would the *probability* of my making a profit be very high?
Not at all.

The probabilities associated with Options, have to be placed in context with entry points, and exit points of the UNDERLYING contract. Thus the probabilities of the underlying [50/50] have to be calculated in addition to the probabilities of the Option series.

This can change quite dramatically the *probabilities* of the overall position.
Add into that the complications of the reward to risk characteristics in regards to money management if actively trading, and only then can you start a POSITION ANALYSIS.

jog on
d998

 

[SOCRATES]

A person can walk into a casino and put £1000 on each of 35 of the 36 numbers. He has 35 chances out of 37 of winning and walking away with £1000 profit. The casino only has 2 chances out of 37 of winning.

Higher likelihood of a win does not make an edge

You are absolutely right.

I used to be a member of the Golden Nugget Casino in Shaftsbury Avenue in London.

I never gambled but used the venue for social purposes.

This casino is very close to the Chinatown district in the West End.

It has a lot of members from the Chinese community there who are regular visitors and very active.

On this particular afternoon I was watching the gaming on one of the roulette tables.

Along comes a Chinese gentleman with a whole lot of chips in both hands and starts to spread them all over the numbers. He covers all the numbers except 36 and Zero.

His wife...who was playing at onother table...spots this and jumps in at the last minute and lays a bet on 36 and Zero. ....While the wheel is spinning the husband and wife have a loud argument...

The spinning stops....the ball lands..

The ball lands on 36.

The argument reaches deafening proportions..

The wife collects her winnings and stomps out...

I will never forget that.

Therfore an edge is more than just a statistical probability in favour of one or the other.
This shows that an edgte is more than just a statistical probability if applied to anything not just ruled by chance outcomes.

 

[andycan]

A person can walk into a casino and put £1000 on each of 35 of the 36 numbers. He has 35 chances out of 37 of winning and walking away with £1000 profit. The casino only has 2 chances out of 37 of winning.

Higher likelihood of a win does not make an edge

the person makes £1000 cool but to give him equal odds he would have to lay out £37000 to make £35000
so the casino makes £2000 everytime for spinning a wheel i take those odds anyday