Expectancy of selling options

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y1980
Posts: 18
Joined: Sun Apr 30, 2023 11:26 am

Expectancy of selling options

Post by y1980 »

I am trying to understand, is the Expectancy of selling options positive/negative or neutral (minus commissions).
Of course, I'm talking after offsetting the positive expectancy of the stock market, and in a theoretical situation where the market expectancy is neutral.
I would very much appreciate links to scientific articles on the subject, or any information.
Thanks
Edit: I'm talking about European options.

My English is not good enough, I hope I was understood.
Last edited by y1980 on Sat Jun 01, 2024 11:59 pm, edited 1 time in total.
bombcar
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Re: Expectancy of selling options

Post by bombcar »

You should find a copy of Options as a Strategic Investment and read it.

The expectancy is neutral before commission, BUT it is very easy to "gamble" with options.

They can act as leverage and as a hedge and there are reasons they exist, but most small time option enjoyers are abusing them.
alex_686
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Re: Expectancy of selling options

Post by alex_686 »

Options are zero sum game. Sort of - the reason why it isn’t are usually covered in graduate level courses.

This is my day job. This is a deep nuanced subject. Feel free to ask me anything.

The standard in options pricing is the Black-Scholes Model followed by the put-call parity formula.

Options, Futures, and Other Derivatives by John Hull is a good place to start.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Lock
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Joined: Sat Oct 05, 2019 8:52 pm

Re: Expectancy of selling options

Post by Lock »

The author of this post specifically asked about selling options. I agree options are net-net zero sum. However, for selling options there is a time decay advantage and/or volatility decay premium(s). Overall, options selling (when done appropriately at the right level of risk) is negative skewed with a positive expected return.

Disclosure: I have an options selling overlay for my portfolio.
comeinvest
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Joined: Mon Mar 12, 2012 6:57 pm

Re: Expectancy of selling options

Post by comeinvest »

Lock wrote: Fri May 31, 2024 2:15 pm The author of this post specifically asked about selling options. I agree options are net-net zero sum. However, for selling options there is a time decay advantage and/or volatility decay premium(s). Overall, options selling (when done appropriately at the right level of risk) is negative skewed with a positive expected return.

Disclosure: I have an options selling overlay for my portfolio.
Time decay means nothing; it's nothing but a mathematical construct with one variable (price of underlying) held constant.

What makes you believe that selling options has positive net return in the long run? It did so the last 20 years or so; but there is no explanation that I am aware of, and I read some articles that say it might reverse in the future.
Is there a risk based explanation, like tail risk or options jump risk that didn't materialize the last 20 years? If so, the expected returns might still be zero.
I have the same question as the OP: What is the expected options return of selling volatility? If it is positive, is the risk correlated with the stock market? Are there any academic studies?
Lock
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Joined: Sat Oct 05, 2019 8:52 pm

Re: Expectancy of selling options

Post by Lock »

Practically speaking regarding monetary rewards time decay, or theta, means an awful lot as an options seller. If there wasn’t a positive expected return - such as the articles mentioned - then people would stop selling options until the system reached equilibrium and there was a positive expected return. The reason positive expected return is anticipated is option sellers provided a service for people who are hedging, neutral market makers, speculators, etc.
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bd7
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Re: Expectancy of selling options

Post by bd7 »

alex_686 wrote: Fri May 31, 2024 11:00 am The standard in options pricing is the Black-Scholes Model followed by the put-call parity formula.
For US options?
Kbg
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Re: Expectancy of selling options

Post by Kbg »

comeinvest wrote: Fri May 31, 2024 8:11 pm
Lock wrote: Fri May 31, 2024 2:15 pm The author of this post specifically asked about selling options. I agree options are net-net zero sum. However, for selling options there is a time decay advantage and/or volatility decay premium(s). Overall, options selling (when done appropriately at the right level of risk) is negative skewed with a positive expected return.

Disclosure: I have an options selling overlay for my portfolio.
Time decay means nothing; it's nothing but a mathematical construct with one variable (price of underlying) held constant.

What makes you believe that selling options has positive net return in the long run? It did so the last 20 years or so; but there is no explanation that I am aware of, and I read some articles that say it might reverse in the future.
Is there a risk based explanation, like tail risk or options jump risk that didn't materialize the last 20 years? If so, the expected returns might still be zero.
I have the same question as the OP: What is the expected options return of selling volatility? If it is positive, is the risk correlated with the stock market? Are there any academic studies?
There's quite a bit of academic work indicating selling options is profitable due to consistent over estimation of actualized volatility...less the geek speak, people pay too much for their stock insurance. I don't claim to know the future, but I would be very surprised to see option selling profitability go away totally. Options are insurance or speculative leverage period. Likely there will always be entities in the market who want to transfer risk so I don't see that element not being somewhat profitable over the long haul. The day it does, is the day options markets cease to exist. No one is going to bare risk for free. However, like a lot things in markets, they have become much more efficient and therefore less profitable.
comeinvest
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Re: Expectancy of selling options

Post by comeinvest »

Kbg wrote: Fri May 31, 2024 11:40 pm
comeinvest wrote: Fri May 31, 2024 8:11 pm
Lock wrote: Fri May 31, 2024 2:15 pm The author of this post specifically asked about selling options. I agree options are net-net zero sum. However, for selling options there is a time decay advantage and/or volatility decay premium(s). Overall, options selling (when done appropriately at the right level of risk) is negative skewed with a positive expected return.

Disclosure: I have an options selling overlay for my portfolio.
Time decay means nothing; it's nothing but a mathematical construct with one variable (price of underlying) held constant.

What makes you believe that selling options has positive net return in the long run? It did so the last 20 years or so; but there is no explanation that I am aware of, and I read some articles that say it might reverse in the future.
Is there a risk based explanation, like tail risk or options jump risk that didn't materialize the last 20 years? If so, the expected returns might still be zero.
I have the same question as the OP: What is the expected options return of selling volatility? If it is positive, is the risk correlated with the stock market? Are there any academic studies?
There's quite a bit of academic work indicating selling options is profitable due to consistent over estimation of actualized volatility...less the geek speak, people pay too much for their stock insurance. I don't claim to know the future, but I would be very surprised to see option selling profitability go away totally. Options are insurance or speculative leverage period. Likely there will always be entities in the market who want to transfer risk so I don't see that element not being somewhat profitable over the long haul. The day it does, is the day options markets cease to exist. No one is going to bare risk for free. However, like a lot things in markets, they have become much more efficient and therefore less profitable.
The "academic" papers that I found purely observe that the realized volatility has been lower than the implied volatility in recent history. I was not able to find an explanation though; and like I said, the options market is not that old, and some experts speculate that this pattern might reverse.
The historical returns were positive for call options writing too, which cannot be interpreted as "insurance" against the stock market risk.
I have a hard time even interpreting put option writing as stock market insurance; each option has a specific negative delta, that neutralizes some of your long stock position if you have any; you could neutralize your long stock and reduce your delta simply by buying less stocks. So no, it's simply a bet on volatility, not specifically on negative delta.
I also read somewhere that deep out of the money put options have proportionally higher prices, as they provide tail risk that "everybody and their mother" likes to have. If true, you must assume that this tail risk eventually materializes at some time; so again, you won't have positive expected returns if you include the tail risk.
It's also not a different asset class where you could argue you might have some anti-correlated returns. Tail risk events would be correlated with your equity portfolio which is usually the bulk of investors' risk allocation.
So, please convince me to start an options writing overlay. I have thought about it many times, but I'm not yet convinced. I hear that retail brokers make a ton of money in commissions and spreads from uneducated retail investors trading options though. Please show me an academic paper that suggest improved risk-adjusted returns for my portfolio. Coincidentally or not, I have not come across any institutional investor or hedge fund engaging in such a strategy; only retail investors.
alex_686
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Re: Expectancy of selling options

Post by alex_686 »

bd7 wrote: Fri May 31, 2024 10:59 pm
alex_686 wrote: Fri May 31, 2024 11:00 am The standard in options pricing is the Black-Scholes Model followed by the put-call parity formula.
For US options?
Kind of. Technically no. Black-Scholes Model prices European options, not American. But that is basic framework everyone starts with. From that you extend to handle American style, dividends, etc.

American options are much much more fiddly and computational intense.

Note, all of the option Greeks are the same. The normal method of learning is to master Black-Scholes and then hire a few quantitative analyst people to keep the option calculator running.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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bd7
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Re: Expectancy of selling options

Post by bd7 »

comeinvest wrote: Sat Jun 01, 2024 2:01 am The historical returns were positive for call options writing too, which cannot be interpreted as "insurance" against the stock market risk...

...I hear that retail brokers make a ton of money in commissions and spreads from uneducated retail investors trading options though...

...Coincidentally or not, I have not come across any institutional investor or hedge fund engaging in such a strategy; only retail investors.
Can you provide the source that shows call writing was profitable? I'm not challenging the assertion, but I'd like to see what and when those results were. I would have thought that calls were actually underpriced a bit because covered call writing is a popular way to juice your stock holdings. I do it and it has been profitable even though I don't do it in a very systematic manner.

As for retail brokers making a ton of money on hapless retail options traders, the fees at most online brokerages are pretty minimal and I only really have to consider them when I'm trading very low value options.

QYLD, XYLD and RYLD are examples of covered call ETFs. As to what hedge funds or large family offices are doing, how would we know?

As for convincing you to use an options overlay, I'll just say that it is a lot of work and not really compatible with Bogle-ish investment strategies.
alex_686
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Re: Expectancy of selling options

Post by alex_686 »

bd7 wrote: Sat Jun 01, 2024 8:59 am
comeinvest wrote: Sat Jun 01, 2024 2:01 am The historical returns were positive for call options writing too, which cannot be interpreted as "insurance" against the stock market risk...

...I hear that retail brokers make a ton of money in commissions and spreads from uneducated retail investors trading options though...

...Coincidentally or not, I have not come across any institutional investor or hedge fund engaging in such a strategy; only retail investors.
Can you provide the source that shows call writing was profitable? I'm not challenging the assertion, but I'd like to see what and when those results were. I would have thought that calls were actually underpriced a bit because covered call writing is a popular way to juice your stock holdings. I do it and it has been profitable even though I don't do it in a very systematic manner.

As for retail brokers making a ton of money on hapless retail options traders, the fees at most online brokerages are pretty minimal and I only really have to consider them when I'm trading very low value options.

QYLD, XYLD and RYLD are examples of covered call ETFs. As to what hedge funds or large family offices are doing, how would we know?

As for convincing you to use an options overlay, I'll just say that it is a lot of work and not really compatible with Bogle-ish investment strategies.
I don’t have the studies at my fingertips, but there is a mild by statically significant that writers of insurance earn a modest return. Deep out of the market calls help.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Lock
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Re: Expectancy of selling options

Post by Lock »

comeinvest wrote: Sat Jun 01, 2024 2:01 am
Kbg wrote: Fri May 31, 2024 11:40 pm
comeinvest wrote: Fri May 31, 2024 8:11 pm
Lock wrote: Fri May 31, 2024 2:15 pm The author of this post specifically asked about selling options. I agree options are net-net zero sum. However, for selling options there is a time decay advantage and/or volatility decay premium(s). Overall, options selling (when done appropriately at the right level of risk) is negative skewed with a positive expected return.

Disclosure: I have an options selling overlay for my portfolio.
Time decay means nothing; it's nothing but a mathematical construct with one variable (price of underlying) held constant.

What makes you believe that selling options has positive net return in the long run? It did so the last 20 years or so; but there is no explanation that I am aware of, and I read some articles that say it might reverse in the future.
Is there a risk based explanation, like tail risk or options jump risk that didn't materialize the last 20 years? If so, the expected returns might still be zero.
I have the same question as the OP: What is the expected options return of selling volatility? If it is positive, is the risk correlated with the stock market? Are there any academic studies?
There's quite a bit of academic work indicating selling options is profitable due to consistent over estimation of actualized volatility...less the geek speak, people pay too much for their stock insurance. I don't claim to know the future, but I would be very surprised to see option selling profitability go away totally. Options are insurance or speculative leverage period. Likely there will always be entities in the market who want to transfer risk so I don't see that element not being somewhat profitable over the long haul. The day it does, is the day options markets cease to exist. No one is going to bare risk for free. However, like a lot things in markets, they have become much more efficient and therefore less profitable.
The "academic" papers that I found purely observe that the realized volatility has been lower than the implied volatility in recent history. I was not able to find an explanation though; and like I said, the options market is not that old, and some experts speculate that this pattern might reverse.
The historical returns were positive for call options writing too, which cannot be interpreted as "insurance" against the stock market risk.
I have a hard time even interpreting put option writing as stock market insurance; each option has a specific negative delta, that neutralizes some of your long stock position if you have any; you could neutralize your long stock and reduce your delta simply by buying less stocks. So no, it's simply a bet on volatility, not specifically on negative delta.
I also read somewhere that deep out of the money put options have proportionally higher prices, as they provide tail risk that "everybody and their mother" likes to have. If true, you must assume that this tail risk eventually materializes at some time; so again, you won't have positive expected returns if you include the tail risk.
It's also not a different asset class where you could argue you might have some anti-correlated returns. Tail risk events would be correlated with your equity portfolio which is usually the bulk of investors' risk allocation.
So, please convince me to start an options writing overlay. I have thought about it many times, but I'm not yet convinced. I hear that retail brokers make a ton of money in commissions and spreads from uneducated retail investors trading options though. Please show me an academic paper that suggest improved risk-adjusted returns for my portfolio. Coincidentally or not, I have not come across any institutional investor or hedge fund engaging in such a strategy; only retail investors.
I mean this with all the love in the world, but this whole paragraph is grossly misinformed.

“I have a hard time even interpreting put option writing as stock market insurance; each option has a specific negative delta, that neutralizes some of your long stock position if you have any; you could neutralize your long stock and reduce your delta simply by buying less stocks. So no, it's simply a bet on volatility, not specifically on negative delta.”
comeinvest
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Re: Expectancy of selling options

Post by comeinvest »

bd7 wrote: Sat Jun 01, 2024 8:59 am
comeinvest wrote: Sat Jun 01, 2024 2:01 am The historical returns were positive for call options writing too, which cannot be interpreted as "insurance" against the stock market risk...

...I hear that retail brokers make a ton of money in commissions and spreads from uneducated retail investors trading options though...

...Coincidentally or not, I have not come across any institutional investor or hedge fund engaging in such a strategy; only retail investors.
Can you provide the source that shows call writing was profitable? I'm not challenging the assertion, but I'd like to see what and when those results were. I would have thought that calls were actually underpriced a bit because covered call writing is a popular way to juice your stock holdings. I do it and it has been profitable even though I don't do it in a very systematic manner.

As for retail brokers making a ton of money on hapless retail options traders, the fees at most online brokerages are pretty minimal and I only really have to consider them when I'm trading very low value options.

QYLD, XYLD and RYLD are examples of covered call ETFs. As to what hedge funds or large family offices are doing, how would we know?

As for convincing you to use an options overlay, I'll just say that it is a lot of work and not really compatible with Bogle-ish investment strategies.
First off, to be honest a give a ?!&% on whether something is "approved" by bogleheads or not. I only go by verifiable evidence, not by some gospel. There are some quite big, almost religious believes and doctrines in this forum, along with citations of whatever "godfather" said decades ago or at a senile age, be it only in a side sentence and often out of context.

The ETFs are retail oriented and often follow herd behavior and popular hypes. I normally come across what institutional investors and hedge funds are doing, including alternative assets and strategies, as I did a lot of reading. Never came across options writing.

The study by CBOE of their options writing indexes are on their web site, and show better risk-adjusted returns than the stock market; however like I said, the historical timeframe of options is naturally limited, and I have not seen any academic study suggesting continued outperformance.
comeinvest
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Re: Expectancy of selling options

Post by comeinvest »

Lock wrote: Sat Jun 01, 2024 4:38 pm
comeinvest wrote: Sat Jun 01, 2024 2:01 am
Kbg wrote: Fri May 31, 2024 11:40 pm
comeinvest wrote: Fri May 31, 2024 8:11 pm
Lock wrote: Fri May 31, 2024 2:15 pm The author of this post specifically asked about selling options. I agree options are net-net zero sum. However, for selling options there is a time decay advantage and/or volatility decay premium(s). Overall, options selling (when done appropriately at the right level of risk) is negative skewed with a positive expected return.

Disclosure: I have an options selling overlay for my portfolio.
Time decay means nothing; it's nothing but a mathematical construct with one variable (price of underlying) held constant.

What makes you believe that selling options has positive net return in the long run? It did so the last 20 years or so; but there is no explanation that I am aware of, and I read some articles that say it might reverse in the future.
Is there a risk based explanation, like tail risk or options jump risk that didn't materialize the last 20 years? If so, the expected returns might still be zero.
I have the same question as the OP: What is the expected options return of selling volatility? If it is positive, is the risk correlated with the stock market? Are there any academic studies?
There's quite a bit of academic work indicating selling options is profitable due to consistent over estimation of actualized volatility...less the geek speak, people pay too much for their stock insurance. I don't claim to know the future, but I would be very surprised to see option selling profitability go away totally. Options are insurance or speculative leverage period. Likely there will always be entities in the market who want to transfer risk so I don't see that element not being somewhat profitable over the long haul. The day it does, is the day options markets cease to exist. No one is going to bare risk for free. However, like a lot things in markets, they have become much more efficient and therefore less profitable.
The "academic" papers that I found purely observe that the realized volatility has been lower than the implied volatility in recent history. I was not able to find an explanation though; and like I said, the options market is not that old, and some experts speculate that this pattern might reverse.
The historical returns were positive for call options writing too, which cannot be interpreted as "insurance" against the stock market risk.
I have a hard time even interpreting put option writing as stock market insurance; each option has a specific negative delta, that neutralizes some of your long stock position if you have any; you could neutralize your long stock and reduce your delta simply by buying less stocks. So no, it's simply a bet on volatility, not specifically on negative delta.
I also read somewhere that deep out of the money put options have proportionally higher prices, as they provide tail risk that "everybody and their mother" likes to have. If true, you must assume that this tail risk eventually materializes at some time; so again, you won't have positive expected returns if you include the tail risk.
It's also not a different asset class where you could argue you might have some anti-correlated returns. Tail risk events would be correlated with your equity portfolio which is usually the bulk of investors' risk allocation.
So, please convince me to start an options writing overlay. I have thought about it many times, but I'm not yet convinced. I hear that retail brokers make a ton of money in commissions and spreads from uneducated retail investors trading options though. Please show me an academic paper that suggest improved risk-adjusted returns for my portfolio. Coincidentally or not, I have not come across any institutional investor or hedge fund engaging in such a strategy; only retail investors.
I mean this with all the love in the world, but this whole paragraph is grossly misinformed.

“I have a hard time even interpreting put option writing as stock market insurance; each option has a specific negative delta, that neutralizes some of your long stock position if you have any; you could neutralize your long stock and reduce your delta simply by buying less stocks. So no, it's simply a bet on volatility, not specifically on negative delta.”
Then have the decency to share your infinite wisdom and be specific, if you already took the time to denounce existing contributions. A forum is to share knowledge and ideas, refute some and support others, to gain greater insight.
In my experience people like you who spew disparaging comments with no substantiation have a narrow horizon and have rarely anything meaningful to contribute anyway nor are capable in dialectic discourse; so just spare your comments.
Last edited by comeinvest on Sat Jun 01, 2024 5:40 pm, edited 2 times in total.
Tanelorn
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Re: Expectancy of selling options

Post by Tanelorn »

I hear Indian options are promising. US ones are probably neutral on average, but of course they could be negative if enough people think they’re some sort of free lunch and keep selling vol regardless of the level due to psychological reasons. Covered calls / option income have a nice price, but it’s no more than that.

It all depends on the price, just like you can’t say whether a stock is good or bad independently of what you’re proposing to pay for it.
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bd7
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Re: Expectancy of selling options

Post by bd7 »

comeinvest wrote: Sat Jun 01, 2024 5:22 pm First off, to be honest a give a ?!&% on whether something is "approved" by bogleheads or not....

...I have not seen any academic study suggesting continued outperformance.
I wasn't referring to options writing being "approved", I was referring to the difficulty in applying an options overlay strategy to a typical Boglehead portfolio. But I could be wrong about that too, perhaps there is an easier way that doesn't bleed fees. In any case, altering your portfolio to suit your options trading habits might be a bad idea.

As for academics, if they could reliably predict outperformance (or anything else) they'd likely be trading rather than publishing. I don't agree that there is insufficient history in options to draw any conclusions. I think better arguments can be made that what happened in the markets 100 years ago is not useful in analyzing todays situation, IOW too much history (considered) is as problematic as not enough. But I also think your question regarding continued outperformance is backwards--have you seen any studies that suggest that options will NOT perform?
Topic Author
y1980
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Re: Expectancy of selling options

Post by y1980 »

alex_686 wrote: Fri May 31, 2024 11:00 am Options are zero sum game. Sort of - the reason why it isn’t are usually covered in graduate level courses.

This is my day job. This is a deep nuanced subject. Feel free to ask me anything.

The standard in options pricing is the Black-Scholes Model followed by the put-call parity formula.

Options, Futures, and Other Derivatives by John Hull is a good place to start.
First, thanks for agreeing to answer questions for me. That's generous of you.
I'm not sure my question was clear enough.
I will try to rephrase it.

I want to examine, what happens to a person who sold options for one year/five years/twenty years, whether in the end he gained, lost or remained with the same balance.
From the point of view of a layman in the field, it seems strange to me that the option sellers will not receive a premium for the insurance aspect they provide, but I want to make sure of that before I start dealing in the field.
What I actually want to do is, sell put options in small batches every day, so basically I get the average distribution of selling options over a long period of time.
But if in the long run no positive result can be expected as a result of selling options, then I will not earn anything from this move.
I will point out that I am talking about selling options of the European type.

And again, thank you.
Topic Author
y1980
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Joined: Sun Apr 30, 2023 11:26 am

Re: Expectancy of selling options

Post by y1980 »

Lock wrote: Fri May 31, 2024 2:15 pm The author of this post specifically asked about selling options. I agree options are net-net zero sum. However, for selling options there is a time decay advantage and/or volatility decay premium(s). Overall, options selling (when done appropriately at the right level of risk) is negative skewed with a positive expected return.

Disclosure: I have an options selling overlay for my portfolio.
I probably didn't understand you properly, as a result of my language barrier.
I would appreciate it if you could explain your strategy to me.
I understand correctly that you buy options to insure your holdings?

In addition, I would appreciate it if you could explain this sentence more to me:
Lock wrote: Fri May 31, 2024 2:15 pm Overall, options selling (when done appropriately at the right level of risk) is negative skewed with a positive expected return.
Thank you.
Thesaints
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Re: Expectancy of selling options

Post by Thesaints »

Writing (i.e. selling) options has a positive expected return.
Not paying for your car’s comprehensive coverage also has a positive expected return.
The two strategies share similarities
comeinvest
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Re: Expectancy of selling options

Post by comeinvest »

y1980 wrote: Sat Jun 01, 2024 11:45 pm
alex_686 wrote: Fri May 31, 2024 11:00 am Options are zero sum game. Sort of - the reason why it isn’t are usually covered in graduate level courses.

This is my day job. This is a deep nuanced subject. Feel free to ask me anything.

The standard in options pricing is the Black-Scholes Model followed by the put-call parity formula.

Options, Futures, and Other Derivatives by John Hull is a good place to start.
First, thanks for agreeing to answer questions for me. That's generous of you.
I'm not sure my question was clear enough.
I will try to rephrase it.

I want to examine, what happens to a person who sold options for one year/five years/twenty years, whether in the end he gained, lost or remained with the same balance.
From the point of view of a layman in the field, it seems strange to me that the option sellers will not receive a premium for the insurance aspect they provide, but I want to make sure of that before I start dealing in the field.
What I actually want to do is, sell put options in small batches every day, so basically I get the average distribution of selling options over a long period of time.
But if in the long run no positive result can be expected as a result of selling options, then I will not earn anything from this move.
I will point out that I am talking about selling options of the European type.

And again, thank you.
Thesaints wrote: Sun Jun 02, 2024 12:01 am Writing (i.e. selling) options has a positive expected return.
Not paying for your car’s comprehensive coverage also has a positive expected return.
The two strategies share similarities
I think that the comparison to "insurance" that is often cited as the reason why the "options writing business" should have positive returns in the long run, is flawed:
1. A "traditional" insurance business insures the risk of individual catastrophic events, by distributing the risk of the individual across the aggregate of insurance holders. For example your home insurance. If your home burns down, you are financially wiped out. From an individual utility function perspective, there is a benefit in insuring i.e. distributing that risk across many members, even if the expected returns of the insurance policy to the policy holder is slightly negative, and slightly positive for the insurance company.
2. The insurance industry is largely viewed by analysts as a rather commoditized industry: Average profit margins are slim, and combined ratios are often even above 100% (which means a loss). Individual insurance companies compete mostly on price, and only a few which apply superior underwriting pricing algorithms or operate in niche markets have relatively consistent returns based on their competitive advantage.

None of that would apply to an options writer:
1. If I employ a consistent SPX options writing strategy, I'm not insuring individual risk by distributing it across an aggregate of insurance members. If there is an unexpected catastrophic event, e.g. the stock market crashes 70% (more than regularly occurring drawdown events), then the entire market i.e. all insureds have the same percentage loss at the exact same time. Who on Earth would insure that? Presumably only somebody who can either hedge or re-insure the risk. I could only hedge that risk by maintaining a corresponding short position in the stock market (e.g. S&P 500), which would defeat the purpose as it's a zero sum game. I also doubt I could get reinsurance for my risk at any price better than a short position in the stock market index and its associated negative expected returns, as somebody at the bottom of the food chain would either have to hedge with a short position, or assume unlimited stock market drawdown risk, which would be equivalent to investing in the stock market by him- or herself.
Most individuals and institutions have a net positive portfolio allocation to equities in the first place; so there is also no diversification benefit of any kind.
2. There is no competitive underwriting advantage to be had in the S&P 500. SPX is SPX. Unless you can reliably forecast the stock market... well, then you can make infinite money in infinite number of ways... unrelated to the subject at hand.

In summary, I think the suggested analogy of employing an options writing strategy as engaging in an insurance underwriting business (and therefore deserving a positive net risk premium in the long run, above and beyond the premium from the stock market delta) is limited, and is not a coherent argument. Writing options is purely a zero sum bet on volatility, and can not be seen as an insurance business justifying positive expected returns beyond the expected risk and return due to the options' exposure to the stock market, as expressed by the options delta.

You either invest in the stock market with an allocation based on your risk profile, or not. "Insuring" the equities market via options or in any other way should theoretically cost the same as the expected returns from the equities market, so you could just net the two positions. Unless you assume that you can price the options better than the market, including all rare tail risk and future catastrophic drawdown assumptions, which would be a totally different argument akin to market timing / having a crystal ball.

The above are my own thoughts in my own (layman) words. But like I said, I have yet to come across any institutional investor, hedge fund, academic paper, white paper, etc., that suggests or examines using options writing as part of an asset allocation or strategy. I would be happy to see any such study. The charts in the CBOE publications are impressive, but purely descriptive and they are not a rigorous study.

I have no explanation for the historically positive options returns; but neither do "experts" seem to have any and like I said, some "experts" question whether it is a persistent phenomenon; or perhaps the seemingly positive returns have a risk-based explanation by excluding drawdown tail risk, which would defeat the purpose as tail risk can materialize, or it wouldn't be a risk. It's easy do devise a derivatives strategy by looking at history, taking the largest historical drawdown, and excluding any risk that is larger than that historical drawdown. You will appear to have a winning strategy, but it's an illusion.

Any explanation would have to separate volatility risk from drawdown risk and adjust for the latter; why would people on average be more adverse to volatility than to market drawdowns, so you could profit from writing options more than from being directly invested in the stock market?
Last edited by comeinvest on Sun Jun 02, 2024 3:02 am, edited 3 times in total.
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Re: Expectancy of selling options

Post by comeinvest »

Thesaints wrote: Sun Jun 02, 2024 12:01 am Writing (i.e. selling) options has a positive expected return.
Not paying for your car’s comprehensive coverage also has a positive expected return.
The two strategies share similarities
That is well said. Except I would say not paying for your car insurance has zero expected return, if you ignore for a moment the insurance company's headquarter overhead of their cost of capital investment into their business that they priced into the policies, cost that doesn't exist in the options market. There is also no individual risk (e.g. one house burning down or one car crashing) that it would make sense to "insure" and spread the loss across an aggregate of insureds.

The commonality however is that in both cases you see positive expected returns if you ignore tail risk events, those that occur rarely or perhaps not even once in your lifetime. What I tried to express in my previous comment.
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Re: Expectancy of selling options

Post by comeinvest »

bd7 wrote: Sat Jun 01, 2024 10:07 pm
comeinvest wrote: Sat Jun 01, 2024 5:22 pm First off, to be honest a give a ?!&% on whether something is "approved" by bogleheads or not....

...I have not seen any academic study suggesting continued outperformance.
I wasn't referring to options writing being "approved", I was referring to the difficulty in applying an options overlay strategy to a typical Boglehead portfolio. But I could be wrong about that too, perhaps there is an easier way that doesn't bleed fees. In any case, altering your portfolio to suit your options trading habits might be a bad idea.

As for academics, if they could reliably predict outperformance (or anything else) they'd likely be trading rather than publishing. I don't agree that there is insufficient history in options to draw any conclusions. I think better arguments can be made that what happened in the markets 100 years ago is not useful in analyzing todays situation, IOW too much history (considered) is as problematic as not enough. But I also think your question regarding continued outperformance is backwards--have you seen any studies that suggest that options will NOT perform?
Agree that the past 40 years might be more relevant than the past 100 years. But then again, many phenomena have cycles of ca. 30-40 years and more, for example some of the equities factor premia, interest rate cycles, swap spreads, or term premia cycles. Options exist for ca. 40 years.

Academia has published about equities factors or example ad nauseam, and this forum is full of it. And just about every other empirical anomaly of the markets.

Implementation is technically not difficult, if that's what you mean. You write in your portfolio margin account every 2 weeks, 3 months, every 12 months or whatever, some SPX put options at the money or x% in or out of the money, as an overlay on your existing portfolio. You want to at least delta-hedge them to target your portfolio equities target allocation; but your broker or free sites will show you your delta at any time. (Don't ask me which roll interval is best on risk-adjusted basis; I researched, and couldn't come up with answers except unfounded opinions on options trading marketing sites. The internet is absolutely full of options trading marketing with little to no intelligent content - either marketing for "programs" to enroll in, or just marketing for site traffic, including Youtube. Rigorous studies however are very hard to come by.)
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Re: Expectancy of selling options

Post by Lock »

comeinvest wrote: Sat Jun 01, 2024 5:32 pm
Lock wrote: Sat Jun 01, 2024 4:38 pm
comeinvest wrote: Sat Jun 01, 2024 2:01 am
Kbg wrote: Fri May 31, 2024 11:40 pm
comeinvest wrote: Fri May 31, 2024 8:11 pm

Time decay means nothing; it's nothing but a mathematical construct with one variable (price of underlying) held constant.

What makes you believe that selling options has positive net return in the long run? It did so the last 20 years or so; but there is no explanation that I am aware of, and I read some articles that say it might reverse in the future.
Is there a risk based explanation, like tail risk or options jump risk that didn't materialize the last 20 years? If so, the expected returns might still be zero.
I have the same question as the OP: What is the expected options return of selling volatility? If it is positive, is the risk correlated with the stock market? Are there any academic studies?
There's quite a bit of academic work indicating selling options is profitable due to consistent over estimation of actualized volatility...less the geek speak, people pay too much for their stock insurance. I don't claim to know the future, but I would be very surprised to see option selling profitability go away totally. Options are insurance or speculative leverage period. Likely there will always be entities in the market who want to transfer risk so I don't see that element not being somewhat profitable over the long haul. The day it does, is the day options markets cease to exist. No one is going to bare risk for free. However, like a lot things in markets, they have become much more efficient and therefore less profitable.
The "academic" papers that I found purely observe that the realized volatility has been lower than the implied volatility in recent history. I was not able to find an explanation though; and like I said, the options market is not that old, and some experts speculate that this pattern might reverse.
The historical returns were positive for call options writing too, which cannot be interpreted as "insurance" against the stock market risk.
I have a hard time even interpreting put option writing as stock market insurance; each option has a specific negative delta, that neutralizes some of your long stock position if you have any; you could neutralize your long stock and reduce your delta simply by buying less stocks. So no, it's simply a bet on volatility, not specifically on negative delta.
I also read somewhere that deep out of the money put options have proportionally higher prices, as they provide tail risk that "everybody and their mother" likes to have. If true, you must assume that this tail risk eventually materializes at some time; so again, you won't have positive expected returns if you include the tail risk.
It's also not a different asset class where you could argue you might have some anti-correlated returns. Tail risk events would be correlated with your equity portfolio which is usually the bulk of investors' risk allocation.
So, please convince me to start an options writing overlay. I have thought about it many times, but I'm not yet convinced. I hear that retail brokers make a ton of money in commissions and spreads from uneducated retail investors trading options though. Please show me an academic paper that suggest improved risk-adjusted returns for my portfolio. Coincidentally or not, I have not come across any institutional investor or hedge fund engaging in such a strategy; only retail investors.
I mean this with all the love in the world, but this whole paragraph is grossly misinformed.

“I have a hard time even interpreting put option writing as stock market insurance; each option has a specific negative delta, that neutralizes some of your long stock position if you have any; you could neutralize your long stock and reduce your delta simply by buying less stocks. So no, it's simply a bet on volatility, not specifically on negative delta.”
Then have the decency to share your infinite wisdom and be specific, if you already took the time to denounce existing contributions. A forum is to share knowledge and ideas, refute some and support others, to gain greater insight.
In my experience people like you who spew disparaging comments with no substantiation have a narrow horizon and have rarely anything meaningful to contribute anyway nor are capable in dialectic discourse; so just spare your comments.
I'm sorry if you too my post as hurtful, not helpful and/or a personal attack. I prefaced my post with "I mean this with all the love in the world" and I really meant it.

With this being said - I appreciate when people point out what they perceive to be errors in my thought. This is part of the process at arriving at the truth!

I believe you're mixing up the way delta functions in portfolios. It's important to distinguish between the option seller and buyer. I put buyer would in fact neutralize their stock exposure. There are a plethora of reasons for why they would want to do this. An options seller doesn't neutralize their stock exposure. It becomes a different animal. The correlation is lower. For instance if you look at PUTQ versus S&P500 it's like 0.78 or so. It's almost exactly like insurance! There are a bunch of different durations and strategies. It's vastly different from just buying an index and holding. A ton more nuance.

I agree that you are betting on volatility being overestimated and underdelivered.

I hope this was helpful. Best of luck and I truly wish you well.
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Re: Expectancy of selling options

Post by grabiner »

"Expectancy" (the standard mathematical term is "expected value") is not really what you care about. Investing is a trade-off between return and risk. Thus a transaction may have a negative expected value (you lose more than you gain on average) but still be a good move. A natural example, outside of investing, is buying insurance: your home insurance company collects more in premiums than it expects to pay, but you have insurance so that you can buy another house if yours burns down.

Options work the same way; the expected return on an option which reduces your risk is less than the risk-free return. If you own a share of stock, and buy a put option, you have limited your losses; the writer of that put is taking part of your risk of loss. The writer will only write this option if they can expect enough of a return to compensate for that risk; they will make a small profit if the put expires worthless, but take a large loss if the stock crashes. This is analogous to insurance; if you have a stock worth $100 and you pay $2 for a put option to sell the stock at $80, you have paid a $2 premium for insurance against a stock decline with a $20 deductible.

Calls can be understood similarly. Writing a call decreases your risk, as it gives you more money if the stock loses value, but less if the call is exercised.

And put-call parity shows how this all works out. If you have a share of stock, buy a put to sell at $100, and write a call to sell at $100, then you will sell at $100 on the expiration date regardless of what happens to the stock. So this combination is a risk-free investment, and should have the same expectation as a Treasury bill maturing on that date; the combination of options gives up both the stock-market risk and the stock-market return.
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Re: Expectancy of selling options

Post by comeinvest »

Lock wrote: Sun Jun 02, 2024 9:38 am
comeinvest wrote: Sat Jun 01, 2024 5:32 pm
Lock wrote: Sat Jun 01, 2024 4:38 pm
comeinvest wrote: Sat Jun 01, 2024 2:01 am
Kbg wrote: Fri May 31, 2024 11:40 pm

There's quite a bit of academic work indicating selling options is profitable due to consistent over estimation of actualized volatility...less the geek speak, people pay too much for their stock insurance. I don't claim to know the future, but I would be very surprised to see option selling profitability go away totally. Options are insurance or speculative leverage period. Likely there will always be entities in the market who want to transfer risk so I don't see that element not being somewhat profitable over the long haul. The day it does, is the day options markets cease to exist. No one is going to bare risk for free. However, like a lot things in markets, they have become much more efficient and therefore less profitable.
The "academic" papers that I found purely observe that the realized volatility has been lower than the implied volatility in recent history. I was not able to find an explanation though; and like I said, the options market is not that old, and some experts speculate that this pattern might reverse.
The historical returns were positive for call options writing too, which cannot be interpreted as "insurance" against the stock market risk.
I have a hard time even interpreting put option writing as stock market insurance; each option has a specific negative delta, that neutralizes some of your long stock position if you have any; you could neutralize your long stock and reduce your delta simply by buying less stocks. So no, it's simply a bet on volatility, not specifically on negative delta.
I also read somewhere that deep out of the money put options have proportionally higher prices, as they provide tail risk that "everybody and their mother" likes to have. If true, you must assume that this tail risk eventually materializes at some time; so again, you won't have positive expected returns if you include the tail risk.
It's also not a different asset class where you could argue you might have some anti-correlated returns. Tail risk events would be correlated with your equity portfolio which is usually the bulk of investors' risk allocation.
So, please convince me to start an options writing overlay. I have thought about it many times, but I'm not yet convinced. I hear that retail brokers make a ton of money in commissions and spreads from uneducated retail investors trading options though. Please show me an academic paper that suggest improved risk-adjusted returns for my portfolio. Coincidentally or not, I have not come across any institutional investor or hedge fund engaging in such a strategy; only retail investors.
I mean this with all the love in the world, but this whole paragraph is grossly misinformed.

“I have a hard time even interpreting put option writing as stock market insurance; each option has a specific negative delta, that neutralizes some of your long stock position if you have any; you could neutralize your long stock and reduce your delta simply by buying less stocks. So no, it's simply a bet on volatility, not specifically on negative delta.”
Then have the decency to share your infinite wisdom and be specific, if you already took the time to denounce existing contributions. A forum is to share knowledge and ideas, refute some and support others, to gain greater insight.
In my experience people like you who spew disparaging comments with no substantiation have a narrow horizon and have rarely anything meaningful to contribute anyway nor are capable in dialectic discourse; so just spare your comments.
I'm sorry if you too my post as hurtful, not helpful and/or a personal attack. I prefaced my post with "I mean this with all the love in the world" and I really meant it.

With this being said - I appreciate when people point out what they perceive to be errors in my thought. This is part of the process at arriving at the truth!

I believe you're mixing up the way delta functions in portfolios. It's important to distinguish between the option seller and buyer. I put buyer would in fact neutralize their stock exposure. There are a plethora of reasons for why they would want to do this. An options seller doesn't neutralize their stock exposure. It becomes a different animal. The correlation is lower. For instance if you look at PUTQ versus S&P500 it's like 0.78 or so. It's almost exactly like insurance! There are a bunch of different durations and strategies. It's vastly different from just buying an index and holding. A ton more nuance.

I agree that you are betting on volatility being overestimated and underdelivered.

I hope this was helpful. Best of luck and I truly wish you well.
Sorry for overreacting.
When I said "neutralize" I meant neutralize at a ratio given by the current options delta, of course.
An options position is a stock market position as given by its delta as first approximation, a bet on volatility as second approximation, and so on. None of that neither the fact that those are approximations refute my thoughts in my other posts, or explain the empirical positive risk-adjusted returns (i.e. lower realized than expected volatility) in recent history.
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Re: Expectancy of selling options

Post by comeinvest »

grabiner wrote: Mon Jun 03, 2024 10:34 am "Expectancy" (the standard mathematical term is "expected value") is not really what you care about. Investing is a trade-off between return and risk. Thus a transaction may have a negative expected value (you lose more than you gain on average) but still be a good move. A natural example, outside of investing, is buying insurance: your home insurance company collects more in premiums than it expects to pay, but you have insurance so that you can buy another house if yours burns down.

Options work the same way; the expected return on an option which reduces your risk is less than the risk-free return. If you own a share of stock, and buy a put option, you have limited your losses; the writer of that put is taking part of your risk of loss. The writer will only write this option if they can expect enough of a return to compensate for that risk; they will make a small profit if the put expires worthless, but take a large loss if the stock crashes. This is analogous to insurance; if you have a stock worth $100 and you pay $2 for a put option to sell the stock at $80, you have paid a $2 premium for insurance against a stock decline with a $20 deductible.

Calls can be understood similarly. Writing a call decreases your risk, as it gives you more money if the stock loses value, but less if the call is exercised.

And put-call parity shows how this all works out. If you have a share of stock, buy a put to sell at $100, and write a call to sell at $100, then you will sell at $100 on the expiration date regardless of what happens to the stock. So this combination is a risk-free investment, and should have the same expectation as a Treasury bill maturing on that date; the combination of options gives up both the stock-market risk and the stock-market return.
It's not the first time that I hear this explanation; but I'm not buying it, for the reasons that I tried to explain in my other post. The analogy to typical insurance which spreads individual catastrophic risk (house burning down) is misguided. There is no risk to spread, and no risk that could be meaningfully insured or reinsured. The whole idea of stock market insurance is misguided. Both your stock market exposure as well as the stock market exposure of a hypothetical insurer would be the sum of the deltas of their respective stock and options positions. The trivial way to "insure" your exposure (i.e. reduce your delta) is to buy less stocks in the first place. There is principally nothing else than exactly that, that an "insurer" can do for you.
I stand by my assertion that buying or selling options is purely a bet on volatility, but cannot be interpreted as "insurance" in any other way than adjusting your stock market beta exposure; or you could perhaps simply define "insurance" as a bet on volatility. This is different from the meaning of "insurance" in the common sense as in home insurance.
This in and by itself does not justify an expected positive premium for the options writer. If you insist that it does, then you should be able to quantify the fair expected return within some risk model framework. Please show me any study that does this; I couldn't find any. Any risk based pricing model of call and put options would have solely the expected return distribution of the underlying as input, including its higher order derivatives (i.e. beyond delta / gamma / Black Scholes, etc.), along with a utility function of the returns. There is no reason to assume that your utility function is different from that of your counterparty, and unless you are a hard core full time quant you are unlikely to prevail with your pricing model. Why would a counterparty assume a nonlinear tail drawdown risk for you, and more willing to assume it than yourself, i.e. give you a better price than you could have by simply reducing your stock positions? I stand by my conclusion that the concept of stock market insurance is nonsensical.
The best explanation for the empirically positive options writing returns that I have is ignored tail risk that market participants assume but that didn't show up in recent history; or a liquidity based explanation - options writers are balance sheet constrained (similar to the explanation for the positive returns of the futures basis trade, or for the implied financing spread of derivatives, or interest rate swap spreads). In this case, similar tail risk or opportunity cost considerations would likewise apply to the retail options writer (probably unknowingly as most don't do a rigorous portfolio optimization including leverage and derivatives). But I am just speculating here; please let me know if you have a reference to some more rigorous paper or study.
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Re: Expectancy of selling options

Post by comeinvest »

To be clear and to put it in other words: I generally struggle with the idea that you can have superior risk-adjusted expected returns with derivatives on an underlying than with the underlying itself, unless you have a superior volatility surface model, or you have different liquidity or balance sheet constraints than eligible counterparties. The question is which one is it.

Backtesting has limited meaning. It's easy to find a strategy that backtests with superior risk-adjusted returns: Step 1: Find the max market drawdown during the backtesting period; I think it was up to ca. 50% in 1987 and 2007-2009. Let's take 50%. Step 2: Write OTM put options with strike prices of 50% of the current index value and roll them periodically, like quarterly. It seems like a perpetual money making machine, and you never lose lost money at expiration; your Sharpe ratio is infinite. You efficient frontier asset allocation is putting all your money into this strategy.
That doesn't mean that there is zero risk of 50%+ drawdowns. It also doesn't mean that you will have higher risk-adjusted returns than just investing in the stock market index. (This example is simplified, as there are some temporary mark-to-market drawdowns; but this is not relevant to the essence of the illustration.)

Now, you can write vertical credit spreads near the money, that I think also showed superior risk-adjusted returns and that don't depend on rare events modeling; e.g. write puts 5% OTM and buy the same amount of puts 10% OTM, on a rolling basis. Can I expect superior risk-adjusted returns than with the market index? If so, what is the explanation? Should I ditch my VTI and VOO, and start writing SPX credit spreads instead, leveraged to a delta of 1 (for example)? I leave this open for further discussion.
P.S.: There are some ETFs for example by Simplify, and probably some CEFs, that do exactly that. But those are retail products that do whatever the herd wants to see, that is addicted to "income" distributions; it doesn't mean it's a viable, rational strategy.
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Re: Expectancy of selling options

Post by secondopinion »

comeinvest wrote: Mon Jun 03, 2024 10:43 pm To be clear and to put it in other words: I generally struggle with the idea that you can have superior risk-adjusted expected returns with derivatives on an underlying than with the underlying itself, unless you have a superior volatility surface model, or you have different liquidity or balance sheet constraints than eligible counterparties. The question is which one is it.
I do not struggle with this at all. There is no uniform definition of risk. Superior risk-adjusted expected returns can exist besides just holding the underlying by using options according to one risk measure; you just have to take inferior risk-adjusted expected returns according to a different risk measure.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
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Re: Expectancy of selling options

Post by comeinvest »

secondopinion wrote: Tue Jun 04, 2024 11:52 am
comeinvest wrote: Mon Jun 03, 2024 10:43 pm To be clear and to put it in other words: I generally struggle with the idea that you can have superior risk-adjusted expected returns with derivatives on an underlying than with the underlying itself, unless you have a superior volatility surface model, or you have different liquidity or balance sheet constraints than eligible counterparties. The question is which one is it.
I do not struggle with this at all. There is no uniform definition of risk. Superior risk-adjusted expected returns can exist besides just holding the underlying by using options according to one risk measure; you just have to take inferior risk-adjusted expected returns according to a different risk measure.
I don't understand your last half-sentence; but the second last half-sentenced is exactly what I said: You have to assume that your volatility surface model (risk model) is superior to that of the counterparties to your trade. It's purely a mathematics game, not subjective; your outcome will be controlled by the movement of the underlying and the realized volatility, and you can make a bet on each, or even on higher level nonlinear behavior. If you expect higher risk-adjusted returns from a derivatives strategy, and everybody agreed with your modeling, then it would be arbitraged away absent liquidity and balance sheet constraints and limits to arbitrage. My aforementioned struggle persists; I hesitate jumping on something that I don't understand, just because of some backtests. And the promotional options writing websites don't provide the needed analysis and understanding.
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Re: Expectancy of selling options

Post by Kbg »

C,

Clearly you don't like the term selling insurance. Fine.

Please explain why a put is purchased?
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Re: Expectancy of selling options

Post by retireIn2020 »

comeinvest wrote: Sat Jun 01, 2024 5:22 pm
bd7 wrote: Sat Jun 01, 2024 8:59 am
comeinvest wrote: Sat Jun 01, 2024 2:01 am The historical returns were positive for call options writing too, which cannot be interpreted as "insurance" against the stock market risk...

...I hear that retail brokers make a ton of money in commissions and spreads from uneducated retail investors trading options though...

...Coincidentally or not, I have not come across any institutional investor or hedge fund engaging in such a strategy; only retail investors.
Can you provide the source that shows call writing was profitable? I'm not challenging the assertion, but I'd like to see what and when those results were. I would have thought that calls were actually underpriced a bit because covered call writing is a popular way to juice your stock holdings. I do it and it has been profitable even though I don't do it in a very systematic manner.

As for retail brokers making a ton of money on hapless retail options traders, the fees at most online brokerages are pretty minimal and I only really have to consider them when I'm trading very low value options.

QYLD, XYLD and RYLD are examples of covered call ETFs. As to what hedge funds or large family offices are doing, how would we know?

As for convincing you to use an options overlay, I'll just say that it is a lot of work and not really compatible with Bogle-ish investment strategies.
First off, to be honest a give a ?!&% on whether something is "approved" by bogleheads or not. I only go by verifiable evidence, not by some gospel. There are some quite big, almost religious believes and doctrines in this forum, along with citations of whatever "godfather" said decades ago or at a senile age, be it only in a side sentence and often out of context.

The ETFs are retail oriented and often follow herd behavior and popular hypes. I normally come across what institutional investors and hedge funds are doing, including alternative assets and strategies, as I did a lot of reading. Never came across options writing.

The study by CBOE of their options writing indexes are on their web site, and show better risk-adjusted returns than the stock market; however like I said, the historical timeframe of options is naturally limited, and I have not seen any academic study suggesting continued outperformance.
I've never heard/read John Bogle suggest using options. Active traders do have that option.
Vanguard offers self-directed investors the ability to trade options, but you'll first need special permission. Options provide unique opportunities to hedge risk or generate income, but they can be highly risky.
Since I'm not an active trader, nor am I a Gordon Gekko type, I stay away from these risky bets.
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Re: Expectancy of selling options

Post by y1980 »

retireIn2020 wrote: Wed Jun 05, 2024 12:29 am
comeinvest wrote: Sat Jun 01, 2024 5:22 pm
bd7 wrote: Sat Jun 01, 2024 8:59 am
comeinvest wrote: Sat Jun 01, 2024 2:01 am The historical returns were positive for call options writing too, which cannot be interpreted as "insurance" against the stock market risk...

...I hear that retail brokers make a ton of money in commissions and spreads from uneducated retail investors trading options though...

...Coincidentally or not, I have not come across any institutional investor or hedge fund engaging in such a strategy; only retail investors.
Can you provide the source that shows call writing was profitable? I'm not challenging the assertion, but I'd like to see what and when those results were. I would have thought that calls were actually underpriced a bit because covered call writing is a popular way to juice your stock holdings. I do it and it has been profitable even though I don't do it in a very systematic manner.

As for retail brokers making a ton of money on hapless retail options traders, the fees at most online brokerages are pretty minimal and I only really have to consider them when I'm trading very low value options.

QYLD, XYLD and RYLD are examples of covered call ETFs. As to what hedge funds or large family offices are doing, how would we know?

As for convincing you to use an options overlay, I'll just say that it is a lot of work and not really compatible with Bogle-ish investment strategies.
First off, to be honest a give a ?!&% on whether something is "approved" by bogleheads or not. I only go by verifiable evidence, not by some gospel. There are some quite big, almost religious believes and doctrines in this forum, along with citations of whatever "godfather" said decades ago or at a senile age, be it only in a side sentence and often out of context.

The ETFs are retail oriented and often follow herd behavior and popular hypes. I normally come across what institutional investors and hedge funds are doing, including alternative assets and strategies, as I did a lot of reading. Never came across options writing.

The study by CBOE of their options writing indexes are on their web site, and show better risk-adjusted returns than the stock market; however like I said, the historical timeframe of options is naturally limited, and I have not seen any academic study suggesting continued outperformance.
I've never heard/read John Bogle suggest using options. Active traders do have that option.
Vanguard offers self-directed investors the ability to trade options, but you'll first need special permission. Options provide unique opportunities to hedge risk or generate income, but they can be highly risky.
Since I'm not an active trader, nor am I a Gordon Gekko type, I stay away from these risky bets.
Even driving a car can be extremely dangerous when you don't understand what you're doing. And options may be safe when you know where you're going.
Assuming that options are a coin toss biased in favor of the seller, selling lots of small options and over time must bring an excess return to the sellers of the options.
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Re: Expectancy of selling options

Post by comeinvest »

retireIn2020 wrote: Wed Jun 05, 2024 12:29 am I've never heard/read John Bogle suggest using options. Active traders do have that option.
I'm not religious when it comes to investing, and as such I don't do lipreading of godlike figures, but I use my brain and verifiable evidence.
retireIn2020 wrote: Wed Jun 05, 2024 12:29 am
Vanguard offers self-directed investors the ability to trade options, but you'll first need special permission. Options provide unique opportunities to hedge risk or generate income, but they can be highly risky.
Since I'm not an active trader, nor am I a Gordon Gekko type, I stay away from these risky bets.
That statement simply shows that you don't understand options (no offense).
comeinvest
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Re: Expectancy of selling options

Post by comeinvest »

Kbg wrote: Tue Jun 04, 2024 11:46 pm C,

Clearly you don't like the term selling insurance. Fine.

Please explain why a put is purchased?
If you are referring to my post - what terms I like or don't like is quite irrelevant to my investment decisions, and should be as irrelevant to yours. What I did is I attempted to analyze the conclusions we might draw from a simplistic analogy, or the lack of them.
A put might be useful in particular idiosyncratic circumstances of an investor, and yes you could say it "insures" the portfolio against a greater loss than the strike price. That is trivial; but as pointed out in the foregoing part of the thread, this has little to nothing to do with the discussion at hand.
secondopinion
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Re: Expectancy of selling options

Post by secondopinion »

comeinvest wrote: Tue Jun 04, 2024 10:02 pm
secondopinion wrote: Tue Jun 04, 2024 11:52 am
comeinvest wrote: Mon Jun 03, 2024 10:43 pm To be clear and to put it in other words: I generally struggle with the idea that you can have superior risk-adjusted expected returns with derivatives on an underlying than with the underlying itself, unless you have a superior volatility surface model, or you have different liquidity or balance sheet constraints than eligible counterparties. The question is which one is it.
I do not struggle with this at all. There is no uniform definition of risk. Superior risk-adjusted expected returns can exist besides just holding the underlying by using options according to one risk measure; you just have to take inferior risk-adjusted expected returns according to a different risk measure.
I don't understand your last half-sentence; but the second last half-sentenced is exactly what I said: You have to assume that your volatility surface model (risk model) is superior to that of the counterparties to your trade. It's purely a mathematics game, not subjective; your outcome will be controlled by the movement of the underlying and the realized volatility, and you can make a bet on each, or even on higher level nonlinear behavior. If you expect higher risk-adjusted returns from a derivatives strategy, and everybody agreed with your modeling, then it would be arbitraged away absent liquidity and balance sheet constraints and limits to arbitrage. My aforementioned struggle persists; I hesitate jumping on something that I don't understand, just because of some backtests. And the promotional options writing websites don't provide the needed analysis and understanding.
You do not understand my statement. What a person will pay in expected returns to reduce risk varies; also, it varies as to what risk is defined as. Both people can enter the same agreement on different sides, and end up winning on a risk-adjusted basis because what they deem as risk is different.

Which is the more correct measure of risk? Drawdown or volatility? It is likely neither, but it is ultimately subjective as to the answer. Likewise, risk-adjusted returns are ultimately subjective.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
secondopinion
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Re: Expectancy of selling options

Post by secondopinion »

comeinvest wrote: Tue Jun 04, 2024 10:02 pm
secondopinion wrote: Tue Jun 04, 2024 11:52 am
comeinvest wrote: Mon Jun 03, 2024 10:43 pm To be clear and to put it in other words: I generally struggle with the idea that you can have superior risk-adjusted expected returns with derivatives on an underlying than with the underlying itself, unless you have a superior volatility surface model, or you have different liquidity or balance sheet constraints than eligible counterparties. The question is which one is it.
I do not struggle with this at all. There is no uniform definition of risk. Superior risk-adjusted expected returns can exist besides just holding the underlying by using options according to one risk measure; you just have to take inferior risk-adjusted expected returns according to a different risk measure.
I don't understand your last half-sentence; but the second last half-sentenced is exactly what I said: You have to assume that your volatility surface model (risk model) is superior to that of the counterparties to your trade. It's purely a mathematics game, not subjective; your outcome will be controlled by the movement of the underlying and the realized volatility, and you can make a bet on each, or even on higher level nonlinear behavior. If you expect higher risk-adjusted returns from a derivatives strategy, and everybody agreed with your modeling, then it would be arbitraged away absent liquidity and balance sheet constraints and limits to arbitrage. My aforementioned struggle persists; I hesitate jumping on something that I don't understand, just because of some backtests. And the promotional options writing websites don't provide the needed analysis and understanding.
If they actually agree on the risk modeling, yes. But no one agrees entirely. Nor should everyone be agreeing as needs are different.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
Kbg
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Re: Expectancy of selling options

Post by Kbg »

comeinvest wrote: Wed Jun 05, 2024 2:35 am
Kbg wrote: Tue Jun 04, 2024 11:46 pm C,

Clearly you don't like the term selling insurance. Fine.

Please explain why a put is purchased?
If you are referring to my post - what terms I like or don't like is quite irrelevant to my investment decisions, and should be as irrelevant to yours. What I did is I attempted to analyze the conclusions we might draw from a simplistic analogy, or the lack of them.
A put might be useful in particular idiosyncratic circumstances of an investor, and yes you could say it "insures" the portfolio against a greater loss than the strike price. That is trivial; but as pointed out in the foregoing part of the thread, this has little to nothing to do with the discussion at hand.
You are quite good at challenging other's thoughts and I value the great insights you have provided in some of your posts which have caused me to rethink. However, I felt I needed to challenge your writing off of the basic purpose and only real reason why someone would purchase a put. This then extends to why someone would sell a put and gets directly at whether or not a profit is likely to continue from selling puts into the future.

Regarding relevance to the OP...poor guy/gal, never got a direct answer to the OP's question. So here's my shot...first a useable definition:

"Expectancy, in the context of trading, is a statistical measure that estimates the average amount a trader can expect to win or lose per trade based on their historical performance. It takes into account both the win rate (the percentage of trades that are winners) and the risk-reward ratio (the average gain of winning trades compared to the average loss of losing trades)."

For options...like most things, it's an it depends. Roughly, at transaction time an option's delta is its expected win rate. Therefore, one part of the calculation is provided by the option itself. The second part, figuring out the gain/loss is also straight forward and provided by the option's premium received when sold. Immediately, it should be apparent that the seller has multiple "option options" at a given point in time from selling way out of the money to near to the money to in the money all of which have a different initial "expectancy." But then reality intrudes, the market moves and changes everything. The terminology is different, but one method of choosing which options to sell involves running all the numbers and picking the one with the highest expectancy and those normally tend to be distant out of the money options. Of note, all of this is computed instantaneously by market makers and while you may not know it, they do.

Getting to the point: To know the expectancy of selling options, one has to pick a strategy(ies), buy some data and test historically what the expectancy is for the strategy when executed repeatedly. There are SO many ways to do options, and as such, is much more difficult than say picking a stock (or whatever) and testing it against a particular trading method to figure out historical expectancy. A Google search will show a number of vendors for such services. I've used Option Omega to do some studies which met my needs, was simple to use, but is not a comprehensive solution. Historical options data is not cheap.

My personal view...it appears option selling is getting more popular and being incorporated into a significant number of ETFs. I would expect that profit potential will continue to decrease and get ever tighter.
comeinvest
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Re: Expectancy of selling options

Post by comeinvest »

secondopinion wrote: Wed Jun 05, 2024 11:13 am
comeinvest wrote: Tue Jun 04, 2024 10:02 pm
secondopinion wrote: Tue Jun 04, 2024 11:52 am
comeinvest wrote: Mon Jun 03, 2024 10:43 pm To be clear and to put it in other words: I generally struggle with the idea that you can have superior risk-adjusted expected returns with derivatives on an underlying than with the underlying itself, unless you have a superior volatility surface model, or you have different liquidity or balance sheet constraints than eligible counterparties. The question is which one is it.
I do not struggle with this at all. There is no uniform definition of risk. Superior risk-adjusted expected returns can exist besides just holding the underlying by using options according to one risk measure; you just have to take inferior risk-adjusted expected returns according to a different risk measure.
I don't understand your last half-sentence; but the second last half-sentenced is exactly what I said: You have to assume that your volatility surface model (risk model) is superior to that of the counterparties to your trade. It's purely a mathematics game, not subjective; your outcome will be controlled by the movement of the underlying and the realized volatility, and you can make a bet on each, or even on higher level nonlinear behavior. If you expect higher risk-adjusted returns from a derivatives strategy, and everybody agreed with your modeling, then it would be arbitraged away absent liquidity and balance sheet constraints and limits to arbitrage. My aforementioned struggle persists; I hesitate jumping on something that I don't understand, just because of some backtests. And the promotional options writing websites don't provide the needed analysis and understanding.
You do not understand my statement. What a person will pay in expected returns to reduce risk varies; also, it varies as to what risk is defined as. Both people can enter the same agreement on different sides, and end up winning on a risk-adjusted basis because what they deem as risk is different.

Which is the more correct measure of risk? Drawdown or volatility? It is likely neither, but it is ultimately subjective as to the answer. Likewise, risk-adjusted returns are ultimately subjective.
But like I tried to explain, yes on the face of it with options you either assume or hedge market drawdown risk above or below a certain threshold; but options pricing can be mathematically reduced to market delta and volatility alone (including higher derivatives i.e. volatility surfaces). Mathematics is always true, not subjective. If you decide to use options on equities or equity indexes in whatever way, long or short, you are expressing an opinion on volatility, not on directional equity market movement, or else you would have adjusted your delta by modifying your equities allocation rather than using options. As mathematics is not subjective, and the mathematics can be reduced to delta and volatilities and related greeks, the excess returns should only be interpreted in terms of delta and volatility surfaces (and subjective opinions on future deltas and volatility surfaces) and possible systematic estimation error by the market of those; not by idiosyncratic or subjective hedging or other portfolio needs of individual market participants. On other words, options returns cannot be explained by risk aversion to directional market movements.
The discussion was prompted by the "explanation" that options writing should generate profits on average, as it is like an "insurance" of directional market risk. Because options per se don't express opinions on directional market movements above or below a threshold, as the problem can be mathematically reduced to exposure to the market itself (delta) and an exposure to volatility, I think that interpretation is not valid.

If money can be made consistently writing options, then the basic assumption would be that an arbitrageur would come along and arbitrage it away. This is independent of someone wanting to hedge at some strike price and their personal perceived utility of that hedge. Options pricing is derived from basic differential calculus, comparing holding the option and holding the underlying as a hedge with no net directional exposure, while the underlying fluctuates up and down. The price of an option is mathematically derived from the volatility assumption of the underlying and nothing else, with no subjectivity. If someone can consistently make money writing options, then options are mispriced.

Someone in the quantitative finance business could probably explain it better than myself.
Last edited by comeinvest on Sun Jun 09, 2024 4:44 am, edited 4 times in total.
comeinvest
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Re: Expectancy of selling options

Post by comeinvest »

Kbg wrote: Wed Jun 05, 2024 1:44 pm You are quite good at challenging other's thoughts and I value the great insights you have provided in some of your posts which have caused me to rethink. However, I felt I needed to challenge your writing off of the basic purpose and only real reason why someone would purchase a put. This then extends to why someone would sell a put and gets directly at whether or not a profit is likely to continue from selling puts into the future.
I don't write off someone wanting to use options for some idiosyncratic portfolio constraint. However I think there is no simplistic explanation for the empirical historical excess returns from options writing.
I think the original question was (re-phrasing it a bit) whether positive returns can be systematically generated with options writing strategies, that are uncorrelated to market returns. The OP doesn't mention explicitly why he is asking; but natural follow-up questions are if and how such strategies might be part of an asset allocation to benefit risk-adjusted expected portfolio returns. I think those interesting questions have not been answered or even seriously examined in this forum. If you say next that it's not boglehead-like, I beg to disagree; and also terminology really doesn't matter. Asset allocation is systematic exposure to systematic risk factors related to assets in financial markets, and how to efficiently implement that exposure, for purpose of maximizing expected risk-adjusted portfolio returns.
Last edited by comeinvest on Sun Jun 09, 2024 4:27 am, edited 1 time in total.
Thesaints
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Re: Expectancy of selling options

Post by Thesaints »

Writing options is similar to writing insurance. On average one makes money.
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y1980
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Re: Expectancy of selling options

Post by y1980 »

comeinvest wrote: Sat Jun 08, 2024 11:32 pm
Kbg wrote: Wed Jun 05, 2024 1:44 pm You are quite good at challenging other's thoughts and I value the great insights you have provided in some of your posts which have caused me to rethink. However, I felt I needed to challenge your writing off of the basic purpose and only real reason why someone would purchase a put. This then extends to why someone would sell a put and gets directly at whether or not a profit is likely to continue from selling puts into the future.
I don't write off someone wanting to use options for some idiosyncratic portfolio constraint. However I think there is no simplistic explanation for the empirical historical excess returns from options writing.
I think the original question was (re-phrasing it a bit) whether positive returns can be systematically generated with options writing strategies, that are uncorrelated to market returns. The OP doesn't mention explicitly why he is asking; but natural follow-up questions are if and how such strategies might be part of an asset allocation to benefit risk-adjusted expected portfolio returns. I think those interesting questions have not been answered or even seriously examined in this forum. If you say next that it's not boglehead-like, I beg to disagree; and also terminology really doesn't matter. Asset allocation is systematic exposure to systematic risk factors related to assets in financial markets, and how to efficiently implement that exposure, for purpose of maximizing expected risk-adjusted portfolio returns.
Thanks for all the arguments you make here.
However, you have to face the question why would people agree to give insurance to another person if they might lose from it?
Are you claiming that the whole reason for this is because of the expected volatility? I allow myself to doubt this because there are too many people who buy options to insure themselves regardless of an accurate assessment of expected volatility.
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Re: Expectancy of selling options

Post by Thesaints »

y1980 wrote: Sun Jun 09, 2024 7:04 am However, you have to face the question why would people agree to give insurance to another person if they might lose from it?
People don’t give insurance to another person (and they should not). Insurance companies give insurance to many people, with uncorrelated risk characteristics.
In fact, these days given the lack of uncorrelation in fire events, insurance companies are exiting that business.

Going back to options writing, individual investors who do write them are “collecting pennies in front of a road roller”.
On the other hand, market makers also write options, but they use dynamic hedging and rely on large volumes to make a profit.
comeinvest
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Re: Expectancy of selling options

Post by comeinvest »

Thesaints wrote: Sun Jun 09, 2024 9:46 am
y1980 wrote: Sun Jun 09, 2024 7:04 am However, you have to face the question why would people agree to give insurance to another person if they might lose from it?
People don’t give insurance to another person (and they should not). Insurance companies give insurance to many people, with uncorrelated risk characteristics.
In fact, these days given the lack of uncorrelation in fire events, insurance companies are exiting that business.

Going back to options writing, individual investors who do write them are “collecting pennies in front of a road roller”.
On the other hand, market makers also write options, but they use dynamic hedging and rely on large volumes to make a profit.
That is correct, like I said before. Market risk is 100% correlated. No point, and impossible to insure as in car or fire insurance.
Market makers make money from market making. That has nothing to do with making money from options.
Last edited by comeinvest on Sun Jun 09, 2024 4:58 pm, edited 1 time in total.
comeinvest
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Re: Expectancy of selling options

Post by comeinvest »

y1980 wrote: Sun Jun 09, 2024 7:04 am
comeinvest wrote: Sat Jun 08, 2024 11:32 pm
Kbg wrote: Wed Jun 05, 2024 1:44 pm You are quite good at challenging other's thoughts and I value the great insights you have provided in some of your posts which have caused me to rethink. However, I felt I needed to challenge your writing off of the basic purpose and only real reason why someone would purchase a put. This then extends to why someone would sell a put and gets directly at whether or not a profit is likely to continue from selling puts into the future.
I don't write off someone wanting to use options for some idiosyncratic portfolio constraint. However I think there is no simplistic explanation for the empirical historical excess returns from options writing.
I think the original question was (re-phrasing it a bit) whether positive returns can be systematically generated with options writing strategies, that are uncorrelated to market returns. The OP doesn't mention explicitly why he is asking; but natural follow-up questions are if and how such strategies might be part of an asset allocation to benefit risk-adjusted expected portfolio returns. I think those interesting questions have not been answered or even seriously examined in this forum. If you say next that it's not boglehead-like, I beg to disagree; and also terminology really doesn't matter. Asset allocation is systematic exposure to systematic risk factors related to assets in financial markets, and how to efficiently implement that exposure, for purpose of maximizing expected risk-adjusted portfolio returns.
Thanks for all the arguments you make here.
However, you have to face the question why would people agree to give insurance to another person if they might lose from it?
Are you claiming that the whole reason for this is because of the expected volatility? I allow myself to doubt this because there are too many people who buy options to insure themselves regardless of an accurate assessment of expected volatility.
Option pricing formulas like Black-Scholes relate volatility to options prices, and are derived by constructing a risk-neutral, hedged portfolio. There is no subjectivity in stochastic calculus; it's pure mathematics. Option writers can hedge their exposure dynamically with the underlying. That means option writers deserve exactly the premium derived from the mathematics, not more and not less. Any perceived profits must come from bets on volatilities as this is the only input variable, e.g. underestimating rare catastrophic events; or from limits to arbitrage. There is no other input that might be subjective. It's hard to argue about mathematics.
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Re: Expectancy of selling options

Post by bd7 »

Thesaints wrote: Sun Jun 09, 2024 1:04 am Writing options is similar to writing insurance. On average one makes money.
That's assuming that some magical force causes everything to priced "correctly". That doesn't happen on its own even for insurance--it's entirely possible for an insurance company to go bankrupt, right? So writing options is only profitable if you have some way of determining the right price to sell them at. A lot of people look at covered call writing as free money and it is the lowest tier (least risky, they'll let anyone do it) of options trading. So I'm thinking that perhaps this artificially lowers the market price of calls.

I've written some longer ATM calls lately (9 months to 2 years) and I've seen large volatility in the price of those calls, more than can be explained by the movement of the underlying or the time that has passed. If I'm very patient I'll sell them only when I'm convinced that they are grossly overpriced--and patience definitely pays off. If I'm impatient and grab at that free cash, I do less well.
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Re: Expectancy of selling options

Post by Thesaints »

comeinvest wrote: Sun Jun 09, 2024 4:47 pm Market makers make money from market making. That has nothing to do with making money from options.
Market making is made through options. MM ideally is never long, nor short.

bd7 wrote: Sun Jun 09, 2024 5:14 pm I've written some longer ATM calls lately (9 months to 2 years)...
What is your hedge ?
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bd7
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Re: Expectancy of selling options

Post by bd7 »

Thesaints wrote: Sun Jun 09, 2024 5:18 pm What is your hedge ?
They're covered--I own the underlying.
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Re: Expectancy of selling options

Post by Thesaints »

bd7 wrote: Sun Jun 09, 2024 5:27 pm
Thesaints wrote: Sun Jun 09, 2024 5:18 pm What is your hedge ?
They're covered--I own the underlying.
OK, so your downside is not financial ruin, but any stock appreciation. It begs the question why invest in stocks at all, if all you are trying to gain is some time value.
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bd7
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Re: Expectancy of selling options

Post by bd7 »

Thesaints wrote: Sun Jun 09, 2024 5:40 pm OK, so your downside is not financial ruin, but any stock appreciation. It begs the question why invest in stocks at all, if all you are trying to gain is some time value.
This particular stock (GOGL) is volatile in price in the medium-term. It pays variable dividends that are sometimes large enough to attract buyers like moths to a flame--that's how I got started with it. I wouldn't write ATM calls for an ordinary stock portfolio and I don't see as much reward in OTM calls for regular stocks--I'll stay much shorter term for those. The price matters and the type of underlying matters. The stock was recently trading over $15 (way high, IMO) and I sold $15 Jan 2025 calls for $2. I'll probably collect $1.20 in dividends between now and then as well.

Since I did this just a few weeks ago, the stock and the option have retreated to $14 and $1 respectively. So $$$ for me in a short time. I see options trading as an inherently market-timing or price-timing enterprise in that there's no inherant 'expectancy' unless you consider price. What I recognized by following this stock and its option chain for a very long time is that $2 for that option meant a very high expectancy of a profit. Now I need to learn to wise up and actually take the profit...
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