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Posted By phg 11 Years Ago
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phg
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Posted Saturday December 09 2006
billb suggested there be a separate thread about options. Let me get the ball rolling.

Options are about statistics. One place where risk/reward - probability of success versus expected return - can be fined tuned is options (only spreads) on the Russell 2000. You benefit from diversification, a near absence of event risk and significantly European exercise (no exercise exposure until the last day). Basically you trade these things by picking your probability of success. For example, this past Friday you could have sold a put at 760 and bought (hedged (spread)) at 750 for a credit of .25. That's $25 for a $1000 risk for a week with about a 95% probability of success. Furthermore, since you can do that each month that annualizes to 30%.

There are two significant downsides. One is, you get greedy and succumb to reaching for return, not heeding the increasing risk. The other is, for the statistics to be meaningful, 5% of the time it is going to go against you. It is essential to have an early, absolutely rigid exit point: at the limit this thing destroys 3 years of returns.

This is frequently turned into an Iron Condor by doing a credit call spead similarly far above the current price; it is extraordinarly unlikely the index will move to both extremes before expiration, so for all practical purposes your risk remains $1000 but with increased intake from this other side.

Rolleyes

-Pete

See also Yahoo group about applying RE.

Posted Saturday December 09 2006
Your first statement is gold.  Options are about statistics.  No strategy is better than another as a general rule, because if it were, you could simply take other profitable side and make money consistenly.  It's all about risk and reward.  As you mentioned, the out of the money credit spreads yield an impressive success rate, but the R/R is 40:1, so you'd have to win about 98% of the time to remain profitable (I think my math is correct). 

phg (12/9/2006)
billb suggested there be a separate thread about options. Let me get the ball rolling.

Options are about statistics. One place where risk/reward - probability of success versus expected return - can be fined tuned is options (only spreads) on the Russell 2000. You benefit from diversification, a near absence of event risk and significantly European exercise (no exercise exposure until the last day). Basically you trade these things by picking your probability of success. For example, this past Friday you could have sold a put at 760 and bought (hedged (spread)) at 750 for a credit of .25. That's $25 for a $1000 risk for a week with about a 95% probability of success. Furthermore, since you can do that each month that annualizes to 30%.

There are two significant downsides. One is, you get greedy and succumb to reaching for return, not heeding the increasing risk. The other is, for the statistics to be meaningful, 5% of the time it is going to go against you. It is essential to have an early, absolutely rigid exit point: at the limit this thing destroys 3 years of returns.

This is frequently turned into an Iron Condor by doing a credit call spead similarly far above the current price; it is extraordinarly unlikely the index will move to both extremes before expiration, so for all practical purposes your risk remains $1000 but with increased intake from this other side.

Rolleyes

phg
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Posted Saturday December 09 2006
Right on all counts. Consistency is absolutely key. (Consistency defined as reliable and repeatable.) Not much in absolute terms, but inexorable compounding is on your side. Where else can you put $1000 at risk with those odds? Put another way, it's worth doing for a dime at those odds.

-Pete

See also Yahoo group about applying RE.

Posted Saturday December 09 2006
And another thing to note is risk management.  With the 40 to 1 R/R, this assumes that you do nothing and "hope" that the position comes back.  Once the short strikes are breached, I think it is wise to consider adjustments (including getting out).  So assuming that you roll up or out when your shorts are breached, your maximum risk is probably not quite as bad as it seems.

Personally, I still can't live with that size of risk.  Being short that much gamma causes nightmares and sometimes I'll see spots.

phg
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Posted Sunday December 10 2006
The risk is $1000. In absolute terms, that's it. But you mention a key point. In other literature you will see it referred to as GTFO. That is always intended to emphasize that, with this strategy, it is nearly essential the one cuts and runs (gets..out) before any breaches. However, picking that point is its own headache.

-Pete

See also Yahoo group about applying RE.

Posted Sunday December 10 2006
So as an options trader, I imagine you have a strategy based on the underlying.  What would you find useful in something like RightEdge to help you further your strategy execution.  As you know, there are a lot more things to consider with options than just the price of the underlying.
phg
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Posted Sunday December 10 2006
billb (12/10/2006)
So as an options trader, I imagine you have a strategy based on the underlying.  What would you find useful in something like RightEdge to help you further your strategy execution.  As you know, there are a lot more things to consider with options than just the price of the underlying.

Your statement may be brief but it poses a challenging question. But my thoughts run this way so far. The first step is selecting the underlying. The second step is selecting a trading strategy for it. Interestingly, for some things you can conclude that buy-and-hold is likely to provide the better total return for awhile. Suppose you find something in a nice uptrend. Naked puts will only capture some of that, even if you ladder up by hedging earlier, mostly good, positions (notice that I do not hedge the new position; it is less expensive to take catastrophy risk out of the old positions). A covered call might take away from you 'too soon'. The odds are against the option buyer. So the question becomes, what is the best strategy for taking advantage of certain kinds of uptrends? I'm thinking a RE stategy might mine the middle ground between options and buy-and-hold. I'm thinking niche, fitting a strategy to a situation.

-Pete

See also Yahoo group about applying RE.

Posted Sunday December 10 2006
You pose some good questions, but I was thinking more along the lines of selecting a strike or strikes, selecting a month or months.  RightEdge does have an options calculator capable of calculating the theoretical price (Black & Scholes as well as binomial) in addition to the implied volatility.  This may or may not aid in buying "cheap" options and selling "expensive" options.  For longer hold times, volatility skew between the months are usually worth noting when detected.  This could be good for calendars or diagonals.

My situation right now is that RE is good for saying "hey, based on backtesting, here's the stocks that will give you an edge today".  At this point, I have some work to do to determine which option strategy makes sense.  I usually like vertical spreads, but sometimes calendars or even butterflies make sense depending on time until expiration or implied volatilities.  I guess selling naked puts doesn't require quite so much work.

phg
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Posted Sunday December 10 2006
Bill, I'm an options guy so most of the time I'm interested in talking about them (endlessly, some say [grin]). My thinking has no where near extended itself into how RE might morph into an options player. (Not to drop the ball here. I do see how RE might be used to signal patterns that might be setups for options plays.)

For now, my thinking is much more near term. Essentially all of my questions are about adding flexibilty to leverage the specatular infrastructure that is already in place. I urge enabling the product to be applied in unanticipated ways. Assume the trader has ways to deal with the situations a strategy is not designed to deal with. Can a sell-only strategy be implemented? Buy only? Provide alerts only (and EOD trader). Some of your customers will simply be interested in merely endlessly tinkering with the technology. You face the 'Hello World' challenge: the simple things the trader thinks he wants to do right away better be just that: simple. After that comes the Stocks and Commodities challenge: can RE implement the same strategies everyone else can, provided in a library for customers? Near term, I see hurdles.

-Pete

See also Yahoo group about applying RE.

Posted Monday December 11 2006
I understand there's a way to go, but thought I'd throw it out there for conversation purposes.  The version after the initial release is already in the planning stages with some of the bigger features pretty well hammered out.  I don't think there's going to be too much in the way of options features.  Just a topic at this point.


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