Options Trading: shooting down the "iron condor"

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Your experience with Options Trading

I do it now
7
10%
I used to do it but not anymore
12
17%
I don't but might someday
5
7%
Nope
45
65%
 
Total votes: 69

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schuyler74
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Options Trading: shooting down the "iron condor"

Post by schuyler74 » Thu Apr 24, 2014 10:47 pm

I'm looking for info that shows clearly why Options Trading is a loser's game but haven't found it searching these forums. Mathematically, it seems obvious that it's a zero-sum game before costs -- so unless you have a long-term algorithm that puts you ahead (after trading costs), then the collective participants should fall into a bell curve where 20% or so got lucky (finished ahead), 20% were unlucky, and the rest fell in the middle somewhere. Of course, the winners typically credit skill while their counterparts blame bad luck.

Next week a coworker will be giving a few of us a presentation on Options Trading. He claims to be in the top 20%. He's not selling anything nor is he personally gaining anything out of it. Now, I'm not going to start trading options, but I will still attend because I'd like to learn more about how it works. Because he's doing this out of his own excitement and passion for the activity, my goal isn't to attack him but I do want him to explain why we shouldn't attribute his success to simply happening to be in the fortunate top 20%.

Here is one link someone gave me to start reading up on it ahead of time: http://www.theoptionsguide.com/iron-condor.aspx, but I'm looking for something explaining why the average options trader can't win in the long run -- assuming that assertion is true! Maybe it isn't.

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bondsr4me
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Re: Options Trading: shooting down the "iron condor"

Post by bondsr4me » Fri Apr 25, 2014 5:43 am

Options trading is not always a losers game. I know; I have traded options for years.
At first, I tried to buy and sell them, but time decay can really smack you around very hard.
After trying different strategies, I stopped buying options; I only sold naked puts and only for companies that I was willing to buy if the option got exercised.
If you want to trade options, my best advice is not to take oversized positions and keep trading costs minimal.
I found Interactive Brokers to be very cheap for options.
Their trading platform, Trader Workstation, is very comprehensive.
The money I did make was not even close to the overall markets' performance.
Just keep in mind that unlike buying a stock or index fund, options will EXPIRE.
This can work for or against you.
As I said in my opening remark though, it is not always a losers game, but you better watch your positions all the time.
Yes, it can be fun (as long as you make money).
Don

YttriumNitrate
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Re: Options Trading: shooting down the "iron condor"

Post by YttriumNitrate » Fri Apr 25, 2014 5:54 am

schuyler74 wrote:then the collective participants should fall into a bell curve where 20% or so got lucky (finished ahead), 20% were unlucky, and the rest fell in the middle somewhere. Of course, the winners typically credit skill while their counterparts blame bad luck.
Wouldn't this also depend on the amount of options trading the participants do? For example, a person who makes a single bet on red at the roulette wheel has a roughly 50% chance of coming out ahead. A person who makes 1000 bets on that same roulette wheel has much less of a chance of coming out ahead.

Valuethinker
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Re: Options Trading: shooting down the "iron condor"

Post by Valuethinker » Fri Apr 25, 2014 9:13 am

My general impression is that the bid offer spread on exchange traded options is large?

Ie to buy or to sell the same contract at the same exercise price and maturity (on the same underlying asset) have very different prices?

That difference is taken up by the intermediaries in the market.

*that* is why if you make money trading options it is due to speculation (aka luck in the absence of inside information) not due to some inherent inefficiency in the options market.

With the exception of deferring capital gains taxes, I always come out that there is no way for an individual investor to profit from options markets (other than by luck). You are playing against professional traders using algorithms and lighthing fast trading who close any anomaly.

What you can do is write covered calls against your portfolio, avoiding having to pay capital gains taxes from liquidation of assets. However my understanding is the premia paid to call writers for liquid stocks is not high, so you are unlikely to make a lot of money that way. And that income will itself be taxable at income tax rates?

This is my limited understanding.

Most personal finance books (that are reputable) recommend against dabbling in options, and I think there's a reason for it. There's too many ways to get burned, such as writing naked calls. On illiquid stocks I believe there is enough inside information around to get really hammered. The trader (or the algorithm) on the other side is very likely to know something you do not.

The only way I know of to minimize the market professionals' advantage over you is to index and trade as little as possible. DFA being the ideal of this, but for most practical purposes Vanguard TSM etc. achieves the same result.

If you happen to know something, eg your employer's stock, then you could get caught in insider trading and the consequences of that are too horrendous to want to engage in it. You might become unemployable for example (or go to prison, or pay huge fines and legal costs).

'I heard it on the grape vine' and 'the Big Chill' echoing in my ears as I type this ;-).

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schuyler74
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Re: Options Trading: shooting down the "iron condor"

Post by schuyler74 » Fri May 02, 2014 7:00 pm

schuyler74 wrote:Next week a coworker will be giving a few of us a presentation on Options Trading. ... I'd like to learn more about how it works.
We had the big meeting today: 1 teacher, 5 students. The whole thing still feels like gambling to me. Instead of long-buying a stock and hoping to flip it after it goes up quickly, or shorting it expecting the price to fall -- you're just guessing about different things. In the same way that the stock market is basically "efficient", the options market is also mostly efficient in that the expectations are built into the prices.

When asked why he comes out ahead in the long run and others don't, If I understood correctly, it comes down to the fact that his "system" is better than whatever system others are using. Is this possible? I feel like it isn't, and even if it were, once a better method becomes public knowledge, isn't the old edge gone? When I asked about this, I recall him saying it's too complicated for most people to bother to understand or to do it correctly. He also noted that he does this inside his Roth IRA so there are no tax implications.

What do you all think?

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ogd
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Re: Options Trading: shooting down the "iron condor"

Post by ogd » Fri May 02, 2014 7:13 pm

I think he doesn't know what he's doing, he bought into some newsletter or book that periodically revises the "system" with what's been working, without ever showing (like mutual fund returns would) the losses sustained by buyers into the old "system".

I think he's up against people 100x more sophisticated than him pricing these things and quietly giggling at the naiveté of the retail buyer, and while he may or may not lose this shirt before becoming disillusioned, chances are he will donate quite a bit of money to Wall Street without even getting a charitable deduction.

That's what I think.

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ogd
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Re: Options Trading: shooting down the "iron condor"

Post by ogd » Fri May 02, 2014 7:18 pm

Valuethinker wrote:What you can do is write covered calls against your portfolio, avoiding having to pay capital gains taxes from liquidation of assets. However my understanding is the premia paid to call writers for liquid stocks is not high, so you are unlikely to make a lot of money that way. And that income will itself be taxable at income tax rates?
Not even this. I'd be assuming all the downside in the asset (still holding it, after all) and only limited upside. Sounds to me like I should get paid a heckuva lot of money for this lopsided endeavor. How much? No idea, which is why I'm not doing it.

Otherwise, agreed on all counts.

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JoMoney
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Re: Options Trading: shooting down the "iron condor"

Post by JoMoney » Fri May 02, 2014 8:04 pm

schuyler74 wrote:...What do you all think?
I think that there are lots of various gambling strategies, people seem to give them more undue credence in the financial markets than in a casino.

I think that options are a great way to generate lots of commissions, good for brokers, bad for traders. Even for someone not "day-trading" the expiration and necessity to roll a position forward creates more trading activity then a buy-and-hold of the underlying asset would require.

I think the ability to synthetically create a leveraged portfolio cheaply in options turns on the fast-money greed switch in some people, who see the potential for large gains, and become blinded to the idea of huge losses (or don't understand how much more risk they're taking relative to the potential gains).

I think that options are derivatives and have no intrinsic value, they're just bets on the future price of a stock. Although the options market has lots of safe guards and surety bonds in place, there is still an element (maybe very small) of counter-party risk... if everybody started reneging on their bets, the options market is way to big for things to unwind in a sane way. In the real world, Black Swans are a fact.

I think if there is any edge to be had, it relies in you having some special knowledge about a specific business situation that the market doesn't know about (not likely for most of us)... and you would need a good reason to believe that situation will be incorporated into the market price within the period of your options contract.

I think if we put the efforts and energy that we devote to trying to create formulas to profit from the ups and downs into actually doing something innovative and productive in the economy we would be better off both individually and as a group. If we even put that kind of energy into getting the management of the companies we own to efficiently run things with a long-term prospective we'd probably be better off. Passively investing (not trading) is one thing, why are we such passive owners though?
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

Beverage
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Re: Options Trading: shooting down the "iron condor"

Post by Beverage » Fri May 02, 2014 9:24 pm

If you want to learn about options you should read Options As A Strategic Investment. But briefly:

- Options trading is a zero-sum game
- You can use options to trade off volatility for expected return, e.g. covered calls reduce volatility therefore also reduce expected return
- You can use options to profit from just about any correct prediction you make about the stock market
- Options are very tax-inefficient
- Omniscience pays off handsomely; false omniscience may lead to ruin

I have gone through a couple options-trading phases in my life. The last time I was making $500 or so per trade pretty consistently. Then I lost $11,000 on one trade and came back to reality.

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baw703916
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Re: Options Trading: shooting down the "iron condor"

Post by baw703916 » Fri May 02, 2014 10:38 pm

I have used options and have ended up with a net gain with them. In particular, I purchased LEAPS (long-term options) on GLD (gold ETF) at various points in time over the last few years. It became clear to me that gold was in a speculative bubble (asset classes with no internal return can't keep appreciating at 20%/year indefinitely). Initially I bet that it would either keep going up or crash--it kept going up. The second round it actually stayed level for about a year, so I lost. Then it dropped quite substantially, and I ended up ahead. Then it leveled out again, and I lost money. Overall a nice but hardly astronomical gain, my Roth has 3-4% more money than it otherwise would due to the options. I also limited my investments to extremely small amounts (<0.5% of my portfolio), so I wasn't going to lose my shirt in any event.

What I did only works in certain rare events--speculative bubbles don't happen all that often. The options market is certainly very efficient, and really I wasn't even trying to compete with other people trading options, I was competing against people piling into the underlying asset class for no good reason. Also there's no information disadvantage regarding the underlying asset (it's a hunk of metal with no earnings, cash flow, or business ventures). GLD is also one of the ETFs with the most liquid options (but long-dated ones are still extremely illiquid, sometimes a week would go by between trades).

Basically I think options only make sense (unless one is seeking leverage without using margin) if an asset class is overvalued due to speculation. If it's undervalued, easier to just purchase the underlying asset.

I don't plan to use options again in the foreseeable future. I don't think that gold is in that much of a speculative bubble currently, nor does there seem to be any other part of the market that has completely taken leave of its senses.
Most of my posts assume no behavioral errors.

ralph124cf
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Re: Options Trading: shooting down the "iron condor"

Post by ralph124cf » Sat May 03, 2014 10:36 am

I use options in two ways. First, if I have a stock in my portfolio that has been going up, and is near the price that I would like to sell at, I can enter a limit order to sell at the price I would like to get. Then if the stock goes up to my price point, the broker executes the sell order.

I could also sell a call at the price I would like to sell the stock at. If the stock goes up, then I will receive the price that I wanted from the stock, and I keep the option premium.

If I am looking at buying a specific stock but it is trading at a price that is above what I am willing to pay, I can enter a limit order to buy at the lower price. Alternatively, I can sell a naked put, and if the stock price drops to the price that I want, then it becomes profitable for the counterparty to exercise the put option, and I would end up with the stock at a price that I had already decided that I want to pay, and I keep the premium for selling the put.

Ralph

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ogd
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Re: Options Trading: shooting down the "iron condor"

Post by ogd » Sat May 03, 2014 1:36 pm

ralph124cf wrote:I use options in two ways. First, if I have a stock in my portfolio that has been going up, and is near the price that I would like to sell at, I can enter a limit order to sell at the price I would like to get. Then if the stock goes up to my price point, the broker executes the sell order.

I could also sell a call at the price I would like to sell the stock at. If the stock goes up, then I will receive the price that I wanted from the stock, and I keep the option premium.
Ah, but these two are not equivalent. With the call option, the buyer can wait until the stock goes significantly higher than the strike price. Meanwhile, your money is stuck in an investment that's not making you any money. This could be at a time when the stock market explodes higher, so you're missing out on the increases in the other things you would have bought with the money; by the time you get back control, many opportunities could have passed you buy. Whereas the limit order gives you the money as soon as the price is met.

You see, the buyer did not just pay you for the right to buy a stock at market price once it crosses X. That would be pretty worthless. They pay you for that opportunity of making gains above $X, while taking little downside risk Like I said above, I think this is a lopsided deal and it should cost a whole lot, and I don't think I'm in a better position to price it than my hedge fund counterpart.
Ralph wrote:If I am looking at buying a specific stock but it is trading at a price that is above what I am willing to pay, I can enter a limit order to buy at the lower price. Alternatively, I can sell a naked put, and if the stock price drops to the price that I want, then it becomes profitable for the counterparty to exercise the put option, and I would end up with the stock at a price that I had already decided that I want to pay, and I keep the premium for selling the put.

Ralph
Same deal -- you might get the stock when the market price is significantly lower than your strike price. Moreover, you have no opportunity to change your mind in the interim, if the stock becomes fundamentally damaged. You are stuck at the mercy of the buyer.

Mind you, I would not use longer term limit orders anyway, since one should always re-evaluate before a transaction, but the contract implicit in the option makes it even worse -- you re-evaluate (sometimes in obvious ways, think oil spill) but are powerless to do anything about it.

gips
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Re: Options Trading: shooting down the "iron condor"

Post by gips » Sun May 04, 2014 11:18 am

I've worked on both the business and technology sides of options platforms for large, well-known, broker dealers. I can speak with some authority on these points:
- the options market is very efficient. Therefore, on a risk adjusted basis where one has to pay transaction fees, it's unlikely anyone can sustain long-term profit.
- there are thousands of professional traders and algos from hedge funds and investment banks trading in the market. These traders have much more knowledge, education and experience than the average retail investor. Due to market efficiency, these traders struggle to make money over the long-term. It's unlikely that a retail trader with a system is going outperform the mean.

you can substitute equities for options in the above statements. This is basis of my flight to index funds 20 years ago.

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magician
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Re: Options Trading: shooting down the "iron condor"

Post by magician » Sun May 04, 2014 11:52 pm

Beverage wrote:If you want to learn about options you should read Options As A Strategic Investment. But briefly:

- Options trading is a zero-sum game
Because of trading costs, options trading is a less-than-zero-sum game.
Simplify the complicated side; don't complify the simplicated side.

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wshang
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Re: Options Trading: shooting down the "iron condor"

Post by wshang » Tue May 06, 2014 10:02 pm

You are asking the question on the WRONG forum. I have traded options for over twenty years and it is not something you dabble nor know a little about. Like any tool in the financial tool box, it has its place. If you are interested, spend a good chunk of time studying. I've worked through this:

http://www.amazon.com/The-Options-Workb ... 1419521071

It is a good basic textbook, but inadequate by itself. After that, I would suggest picking up a more in depth book and thoroughly absorb that. Maybe by that time you are ready to do some paper trading.

It is possible to make money and overly simpleminded to characterize it a zero-sum-game. Successful option strategies require a strong sense of math and ultimately second and third tier planning.
“. . . extraordinary wealth can be made by knowing the future" - Harry Dent

SpaceCowboy
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Re: Options Trading: shooting down the "iron condor"

Post by SpaceCowboy » Wed May 07, 2014 3:03 am

If you want to speculate on the price of a stock, trade the stock.
Options are used to trade on the volatility of the stock or underlying index. The key variable in the pricing of options is the volatility of the underlying security. If you don't have an opinion on the volatility of the underlying security versus the volatility implied in the option's price, then don't trade the option.
For the retail investor, it makes almost zero sense to trade options. The combination of bid ask spreads (which are higher on a percentage basis than stocks) and commissions, makes the trading cost excessive, especially when many option positions require at least two trades or legs to open and two to close. So now you are looking at 4 commissions plus 2-4 bid ask spreads to effectively get through a single position. It's a good business for the brokers and the professionals on the other side of your trade who can lay off the risk quickly at much lower trading costs.

Valuethinker
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Re: Options Trading: shooting down the "iron condor"

Post by Valuethinker » Wed May 07, 2014 5:09 am

rrppve wrote:If you want to speculate on the price of a stock, trade the stock.
Options are used to trade on the volatility of the stock or underlying index. The key variable in the pricing of options is the volatility of the underlying security. If you don't have an opinion on the volatility of the underlying security versus the volatility implied in the option's price, then don't trade the option.
For the retail investor, it makes almost zero sense to trade options. The combination of bid ask spreads (which are higher on a percentage basis than stocks) and commissions, makes the trading cost excessive, especially when many option positions require at least two trades or legs to open and two to close. So now you are looking at 4 commissions plus 2-4 bid ask spreads to effectively get through a single position. It's a good business for the brokers and the professionals on the other side of your trade who can lay off the risk quickly at much lower trading costs.
Thank you for this, which is an extremely sensible and real world analysis of what is going on.

As rrpve points out, options traders trade implied volatility, not price. Options are priced on their VOL as I understand it.

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Ketawa
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Re: Options Trading: shooting down the "iron condor"

Post by Ketawa » Wed May 07, 2014 7:20 am

I learned just enough about options to execute some trades as part of a TLH strategy. I wrote about it in this thread: Generating TLH opportunities by writing call options.

I wrote naked calls against ETFs with liquid options markets and covered them with similar ETFs (like a TLH pair) that I would be comfortable holding long term. This creates a position similar to a fixed income position since you earn the time premium, and my annualized return over the 4 months with the position was about 2%. This makes it possible to generate capital losses if the market goes up. I'm no longer executing the strategy since I liquidated my taxable account for a home down payment.

Park
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Re: Options Trading: shooting down the "iron condor"

Post by Park » Wed May 07, 2014 7:48 am

I am far from an expert on options. But my perception is that they're best used by those with a comparatively short investing time horizon, such as those who invest using technical analysis. For those with a longer time horizon (more than 2 years, such a value investors), their use is limited. For those who buy and hold (an example being index investors), their use is more limited yet.

An exception would be the use of options to obtain leverage in a tax advantaged account.

The amount of time it takes to learn about options is not small. IMO, the ratio of of investment return to time spent generating that return is lower in options than elsewhere in investing.

3504PIR
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Re: Options Trading: shooting down the "iron condor"

Post by 3504PIR » Wed May 07, 2014 9:40 am

define "trading." Does it include using options as a hedge? Does it include selling covered calls?

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