Watch HowardCohodas Trade Index Options Credit Spreads

[meanreversion]

Now that gamma exposure has become the crux of the concerns for my methods, I will monitor and report it for a while. It will also improve my visceral vs. intellectual understanding of the greeks.

First of all, it would help you considerably if you could carry out some basic risk analysis on your option portfolio. What is your delta and gamma with the market here, and then +/- 1 pct, 2 pct, up to 10 pct move in spot. This will give you a much better idea of how your position changes when the underlying market moves.

Ok, back to "gamma". There is nothing wrong with being short gamma (or long gamma) if there is a view that implied vol is rich (or cheap). You profess to having no such view.

In addition, you have no directional view, nor are you able to articulate an edge that you believe you might have.

So what do you have.. a direction neutral position with little exposure (according to you) where you're not expressing a view on anything, and yet this magic position enables you to make 10% a month.

Think about it for a bit.

Do you REALLY think that shuffling a few strikes around, whilst never having a view on direction or vol, is going to make you money in the long run? Seriously? No view and no risk, yet 50-100% a year?

I'm going to step out of this now, as it has become very circular. It is very clear to me that your knowledge of options is limited at best, and yet you are happily trading condors and shifting strikes around, without understanding some fairly basic options theory. Again, does this sound like a plausible recipe for success?

Good luck Howard.

 

[HowardCohodas]

First of all, it would help you considerably if you could carry out some basic risk analysis on your option portfolio. What is your delta and gamma with the market here, and then +/- 1 pct, 2 pct, up to 10 pct move in spot. This will give you a much better idea of how your position changes when the underlying market moves.

I have done sensitivity analyses on parameters of my methods. The purpose of a sensitivity analysis is to discover how the result changes for small changes in the control parameters. One wants to discover of the parameter settings have you "balanced on a pin." It sometimes even uncovers a "cliff" where a small change causes the result to change dramatically.

I have not done a sensitivity analysis with respect to the greeks as they are a derived characteristic of the portfolio and not a method I use in controlling or creating it.

While I do not yet have a "university" view of the results of a sever market move (my only significant market move risk), I do have a good "trade school" view. The 5 years of data that I used for backtesting, the 5 months I paper traded and the 19 weeks I've live traded makes clear that my analysis in this post, is an accurate representation of reality as I've observed it.

Ok, back to "gamma". There is nothing wrong with being short gamma (or long gamma) if there is a view that implied vol is rich (or cheap). You profess to having no such view.

OK. Now gamma is not the crux of my difficulties.

In addition, you have no directional view, nor are you able to articulate an edge that you believe you might have.

In communication theory, failure to communicate is not always the fault of the sender. There is the medium and the receiver to add noise to the message received.

So what do you have.. a direction neutral position with little exposure (according to you) where you're not expressing a view on anything, and yet this magic position enables you to make 10% a month.

Not quite the way I would have stated it, but the result is accurate. To what do you attribute the result?

Think about it for a bit.

Do you REALLY think that shuffling a few strikes around, whilst never having a view on direction or vol, is going to make you money in the long run? Seriously? No view and no risk, yet 50-100% a year?

Irrespective of my ability to successful communicate what is going on, how are the results I see possible?

I'm going to step out of this now, as it has become very circular. It is very clear to me that your knowledge of options is limited at best, and yet you are happily trading condors and shifting strikes around, without understanding some fairly basic options theory. Again, does this sound like a plausible recipe for success?

Agreed, I do not have a strong knowledge of options. How do you account for the results I've achieved?

Good luck Howard.

Thank you. Luck is always an important component to success. But then I've always attributed good luck to preparation.

 

[HowardCohodas]

Is Howard a Bumblebee?

In many ways this recent dialog (or competing monologues, I'm not certain which) reminds me of the bumblebee. For the longest time aeronautical engineering analysis "proved" that a bumblebee could not fly. And the bumblebee was unable to successfully explain to the engineers why he really could fly. Engineers persisted until they could understand the aerodynamics of a bumblebee and explain it mathematically.

Is my current level of success a well crafted illusion or an anomaly that current analysis methods cannot explain? Am I a bumblebee or a figment of my own imagination?

 

[MrGecko]

My Z$ 0.02

As someone with very little experience of options I am hoping that my explanation of what I think is going on here is accurate but not "dumbed down' so far as to be naive.

Now, when people put on an option trade, they are usually speculating on at least one of the following:

1) Direction

As in, the "implied probability"** of this option ending up ITM is below the actual probability - so I'll take a direction bet on the mis-price between implied probability of reaching strike XXX and what I believe the actual probability of reaching strike XXX

2) Volatility

Similarly, the volatility implied by the option is mis-priced against what I think the realised volatility will be - so I'll take a bet on the difference between implied and realised volatility throughout the life of the option.

Now, Howard - from what I have read (tbh most is tldr) you are trying to sell as close to the money Iron Condors as you can. If I look at the expiry payout of an ATM Iron Condor, it's symmetrical - the wings and body of the left and the right are the same. Intuitively, this says to me that you are not taking a directional bet on the market, because if you were your "Price of Spot @ expiry vs. Intrinsic value of IC" graph would be lopsided.

So, it's clear to me that you are not taking a directional view. Thus, you must be taking a view on volatility...

... by selling options (or any combination thereof) and receiving a credit, combined with a symmetrical "spot vs expiry" graph like I described above, the view that is consistent with your position is "I think that realised volatility will be less than the implied volatility that the options are trading at".

I am pretty certain that you're edge isn't because of some mis-pricing between two different spreads, or because your counterparties have objectives that are not a mirror image of yours. I don't know if it will help or hinder, but try a google search for "gamma scalping". As I understand it people that scalp gamma are saying "realised volatility will be more than is implied, and enough to cover by theta decay". I suggest it because, as far as I can see, they are taking a view that is opposite to yours but explain where their edge is convincingly.

** There is a thing by the BOE somewhere about using short sterling options to find out implied probabilites... in the end they produce something that looks like a volatility cone but with spot prices. Just FYI.

 

[MrGecko]

Re: Is Howard a Bumblebee?

Is my current level of success a well crafted illusion or an anomaly that current analysis methods cannot explain? Am I a bumblebee or a figment of my own imagination?

You are a bumblebee without any wings that has just been fired from a catapault. You're flying until you crash.

To infinity, and beyond!

:cheesy:

 

[scose-no-doubt]

Howard I came to this site in early 2009 and thought I was the sh1t because I was profitable with trading S&R TA from the get go. Nobody could tell me anything. I was the most egotistical, overly confident, arrogant little sh1t you could imagine and not to mention thick as pig sh1t.
I was shorting the Dow Jones during the crisis.
I later went on to lose all of my profits and about a grand (which a lot of money to me) because I just didn't know what I was really doing. I'll never forget the dates March 9th or July 13th 2009 (pull up a chart).
Hope you don't make the same mistake I did with a far larger sum of money.

 

[HowardCohodas]

Re: Is Howard a Bumblebee?

You are a bumblebee without any wings that has just been fired from a catapault. You're flying until you crash.

To infinity, and beyond!

:cheesy:

Unless, of course, I have launched with sufficient velocity to remain in orbit.

 

[HowardCohodas]

Howard I came to this site in early 2009 and thought I was the sh1t because I was profitable with trading S&R TA from the get go. Nobody could tell me anything. I was the most egotistical, overly confident, arrogant little sh1t you could imagine and not to mention thick as pig sh1t.
I was shorting the Dow Jones during the crisis.
I later went on to lose all of my profits and about a grand (which a lot of money to me) because I just didn't know what I was really doing. I'll never forget the dates March 9th or July 13th 2009 (pull up a chart).
Hope you don't make the same mistake I did with a far larger sum of money.

I hope you do not construe vigorous Socratic debate as arrogance.

I have tried to answer every question to the best of my ability, sometimes with humor, but never with any intention to communicate that I know everything.

I think I have a well thought out and practical method of assessing the performance of the major components of my system. I've described methods of detecting deterioration in the performance of the trader (me). And I have described my method of detecting the deterioration in the performance of my strategy for any reason, including systemic changes in the market.

If I stick to that discipline, can you think of any reason why I should lose the majority of my account as so many sages have predicted in this thread?

 

[scose-no-doubt]

Didn't mean to sound as though I saying you're at all like I was. I was just relaying my bad experiences in dealing with something I didn't understand. You don't seem arrogant to me at all and are you seem far smarter than me however I think you were being a bit tunnel vision-ish in your approach to analysis and that you are taking far too a simplistic view on your markets.
This seems to stem more from limitation of scope rather than inability but I'm just saying...
All that being said I cant argue with your returns
Best of luck and I hope it doesn't run out before you learn how to manage the full extent of exposure.
I'll stop bothering you so much now and let you get on with it but I'll continue to watch with interest

 

[HowardCohodas]

I am pretty certain that you're edge isn't because of some mis-pricing between two different spreads, or because your counterparties have objectives that are not a mirror image of yours.

Close

My edge is not because of mis-pricing between two legs of a spread.

My edge is not because of a mis-estimate of volatility.

My opportunity (call it edge if you will) is that the preponderance of the option volume is devoted to applications other than credit spreads. Thus, for the relatively small volume devoted to credit spreads, great return is possible. Should the options market undergo systemic change, this may no longer be true. I have a quality assurance process in place to spot this and withdraw before any significant harm comes to may account.

As the expiration date nears, time decay, the source of my return, begins to accelerate. This begins to impact, but not dominate, the volume for those options. The only relevance of this idea to what I do is that opportunities begin to diminish, but only slightly. This is an observation, not an analysis.

 

[MrGecko]

My opportunity (call it edge if you will) is that the preponderance of the option volume is devoted to applications other than credit spreads.

What you say here might be true Howard, but I can't see how that can be exploited into a discernable edge.

 

[HowardCohodas]

What you say here might be true Howard, but I can't see how that can be exploited into a discernable edge.

I don't know if I'm getting warmer, but I did an interesting study today. I took the NDX JAN 11 PUT quotations for the close on 11/19/2010 and consolidated some alternatives into a spread sheet and a chart.

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.

 

[DionysusToast]

You are standing up well here so far, Howard.

As it had been hard for us other members to understand you edge - perhaps we can be shown to understand if we ask the same question in a different way.

One of the characteristics all edges have is that they will fade if too many people trade them. An edge that doesn't fade with overuse is akin to a perpetual motion machine.

So - let's say that hundreds, then thousands, then hundreds of thousands of people all traded your system in the same way. By what mechanism would the edge gradually disappear?

 

[HowardCohodas]

You are standing up well here so far, Howard.

As it had been hard for us other members to understand you edge - perhaps we can be shown to understand if we ask the same question in a different way.

One of the characteristics all edges have is that they will fade if too many people trade them. An edge that doesn't fade with overuse is akin to a perpetual motion machine.

So - let's say that hundreds, then thousands, then hundreds of thousands of people all traded your system in the same way. By what mechanism would the edge gradually disappear?

Thank you for the compliment. It means a lot to me.

By what mechanism would the edge gradually disappear?
Your question has focused my thoughts and I am now nearing changing my opinion.

My position was that if the preponderance of options activity were to shift to credit spreads, the credit would likely narrow. I now have serious doubts. First, if that were the case then more of the transactions would be of the form that one trader would be taking my opposite position. Who would consistently do such a thing? Currently, I believe that more than one trader is involved in taking each of the legs of the spread I sell.

Secondly, if you believe in the options pricing formulations, there are few choices for the cause of a narrowing of the credit received. Of the inputs to the pricing models; underlying instrument price, strike price, time to expiration, risk free interest rate, and volatility, only one is a variable for any given instant in time, i.e. volatility.

So the question becomes, can a significant change in the use of options cause the underlying instrument price volatility to change? I don't see how! I need wiser counsel here.

Therefore, without a change in the use of options as a mechanism to reduce the current opportunity, I'm left with the somewhat uncomfortable conclusion that the opportunity is built into the system. However, it that were true, why are there relatively few of us practicing this technique?

Call me confused.

 

[HowardCohodas]

13 DEC 2010 Trading Plan from Dashboard

Opportunity
    Incomplete Iron Condors
         8 - DEC 10  - RUT - Caution: 3 days to expiration
        13 - DEC5 10 - SPX

    Roll Candidates
        13.P - DEC5 10 - PUT - SPX
        16.P - JAN 11  - PUT - RUT
        17.P - JAN 11  - PUT - SPX
        
    New Spreads
        None 

Jeopardy
        None

 

[Dommo]

So - let's say that hundreds, then thousands, then hundreds of thousands of people all traded your system in the same way. By what mechanism would the edge gradually disappear?

Like any other market - under finite liquidity the price made by market makers will become less favourable until the incentive to enter the trade disappears. If there are lots of buyers of option A at strike A and lots of sellers of option B at strike B, option A quote will increase, and option B quote will decrease. Market maker will just mark his vol surface accordingly, however anomalous that might make the surface look. Precisely the same thing applies on exit.

This is not a remark on the viability of Howard's strategy in lesser quantities - it is a remark on the limitations of finite liquidity, which apply to options as for anything else.

 

[scose-no-doubt]

So the question becomes, can a significant change in the use of options cause the underlying instrument price volatility to change? I don't see how! I need wiser counsel here.

1 way
http://learning.saxobank.com/forex/options/knockout-reverse.aspx

 

[MrGecko]

So the question becomes, can a significant change in the use of options cause the underlying instrument price volatility to change? I don't see how! I need wiser counsel here.

I don't think you should be focusing on the way the options are used because I don't think it impacts upon the price at all. Options are priced by very fancy computers run by banks and hedge funds, and if any one price becomes dislocated from the others there are algos to arb them back into line.

 

[DionysusToast]

Of course, you picked a bloody awkward instrument to trade when it comes to understanding the relationship between the derivative and the underlying. The indices have both options and futures to consider when looking at the underlying. Obviously the futures volume overshadows the options volume completely and so does their impact.

Still - all derivates have a relationship with the underlying and there are many 'tail' and 'dog' discussions to be had, especially when talking about the 3 indices in question.

This could get you to the crux of the issue or it could be a diversion. It could just be that prices are fair.

BTW - I just missed a short posting this... grrrr...

 

[meanreversion]

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.

There are two types of so-called digital options. Those that pay off if the barrier is touched at any point during the life, and those which pay off at expiry if spot is beyond the chosen level.

As a very crude approximation, the "one touch binary" usually has a premium equal to twice that of the "at expiry digital" (where the premium is expressed as a percentage between 0-100).

Based on the underlined section, are you using the one touch binary price as a proxy for the odds of finishing beyond the strike at expiry?