With casinos closed, can we take our risk management skills to trading options during this volatility?
- Thread starter Toxic
- Start date
To be clear, I'm still learning. However, I try to make every trade a situation where I am happy to take either scenario (exercise or not).
I've only got experience with European Options (can only exercise option on the expiry date)
The current market I'm interested in (because I "think" I understand it) is Bitcoin options.
Regardless of how you feel about this particular asset, please let me know if my reasoning is missing anything. You could substitute a certain stock that you want to buy in place of BTC. Just be certain that you WANT to hold the asset at a lower price than is available right now.
So... Here's the strategy I've been testing:
Current Price: $6,738
May 29 Put Option with a Strike Price of $5,000
Spread is currently 168 to 331.
I would chose to Sell a Put here with a limit price of $331. (I actually got a better price, but that's irrelevant for this example)
So there are two possibilities:
1) I make $331 in premium if the price of BTC is $5000 or greater and the person who bought the put chooses not to exercise.
2) The price of BTC goes below $5000 and I get filled. My price is definite. It is Strikeprice - Premium. In this case $5000 - $331 = $4669.
So I will either earn $331 in premium, or get to buy this asset at $4669 when it is currently trading at $6,738. That's a 30% discount!
with Option 1: in slightly less than 2 months. I've made $331 with $5k. That's 6.62% over 2 months or (multiply by 6) 39.72% annualized.
with Option 2: I've got a 30% discount of an asset that I ALREADY WANT. I could end up with a paper loss (if the price drops below $4669) that I am OK with holding on to for a term of 3+ years.
_______
So that's a basic strategy that I like. I do understand that selling a put has the possibility that I can lose 100%, in this case $4669. If I were bearish, in the same example, I could try to buy the put, at $168. I would be essentially paying $168 for insurance that the price would not go below $5000. If it did, I would be able to still sell at $5k. My average sale price would be ($5000 - $168) = $4832.
I also understand that the spread from $168 to $331 is the difference between sellers and buyers. I have been choosing the top end of the spectrum, which leads to pending orders only at that price. If the price of the underlying asset moves, that spread will move. It allows me to "set it and forget it". If the trade gets filled, GREAT. If the trade doesn't get filled, THAT's OKAY, because I haven't lost anything.
____
Next question: How do I calculate EV when I don't know the likelihood of an event actually taking place?
For example: If I believe there is a greater than 1/10 chance that the price will increase by 10x, I would take the bet. If there was less than a 10% chance, I would not. And Exactly 10% would provide 0 EV.
BUT... I can't calculate the % chance of the price increasing...
All I can do is speculate. Based on the mental models that I am running.
Thoughts and feedback please?
I've only got experience with European Options (can only exercise option on the expiry date)
The current market I'm interested in (because I "think" I understand it) is Bitcoin options.
Regardless of how you feel about this particular asset, please let me know if my reasoning is missing anything. You could substitute a certain stock that you want to buy in place of BTC. Just be certain that you WANT to hold the asset at a lower price than is available right now.
So... Here's the strategy I've been testing:
Current Price: $6,738
May 29 Put Option with a Strike Price of $5,000
Spread is currently 168 to 331.
I would chose to Sell a Put here with a limit price of $331. (I actually got a better price, but that's irrelevant for this example)
So there are two possibilities:
1) I make $331 in premium if the price of BTC is $5000 or greater and the person who bought the put chooses not to exercise.
2) The price of BTC goes below $5000 and I get filled. My price is definite. It is Strikeprice - Premium. In this case $5000 - $331 = $4669.
So I will either earn $331 in premium, or get to buy this asset at $4669 when it is currently trading at $6,738. That's a 30% discount!
with Option 1: in slightly less than 2 months. I've made $331 with $5k. That's 6.62% over 2 months or (multiply by 6) 39.72% annualized.
with Option 2: I've got a 30% discount of an asset that I ALREADY WANT. I could end up with a paper loss (if the price drops below $4669) that I am OK with holding on to for a term of 3+ years.
_______
So that's a basic strategy that I like. I do understand that selling a put has the possibility that I can lose 100%, in this case $4669. If I were bearish, in the same example, I could try to buy the put, at $168. I would be essentially paying $168 for insurance that the price would not go below $5000. If it did, I would be able to still sell at $5k. My average sale price would be ($5000 - $168) = $4832.
I also understand that the spread from $168 to $331 is the difference between sellers and buyers. I have been choosing the top end of the spectrum, which leads to pending orders only at that price. If the price of the underlying asset moves, that spread will move. It allows me to "set it and forget it". If the trade gets filled, GREAT. If the trade doesn't get filled, THAT's OKAY, because I haven't lost anything.
____
Next question: How do I calculate EV when I don't know the likelihood of an event actually taking place?
For example: If I believe there is a greater than 1/10 chance that the price will increase by 10x, I would take the bet. If there was less than a 10% chance, I would not. And Exactly 10% would provide 0 EV.
BUT... I can't calculate the % chance of the price increasing...
All I can do is speculate. Based on the mental models that I am running.
Thoughts and feedback please?
You have a decent fundamental understanding of the classic strategy of selling an OTM put.
A few comments: with a huge spread such as 168-331, you can always dream of selling the offer or buying the bid, but it is completely unreasonable to think that that is how you will get filled. If, in fact, you did manage to sell the offer, it's because the price of the underlying moved, which changes the dynamic of the spread.
You also have to be aware of what can happen in very volatile times, such as these, and with an incredibly volatile underlying such as bitcoin. Markets sometimes gap, and then don't always give you a chance to react quickly enough to protect your short position. Your write-up above has what we refer to as an "expiration mentality," in that it only considers remaining in the position until expiration. But what if bitcoin gaps down considerably, and before you have time to react, or defend yourself, the price is, say, 4,000, or 3,000, or worse. Now what? Are you still happy to buy it at 5,000 (minus the premium)? Clearly, not.
A quick story. During the crash of October 1987, I was on the index options and futures proprietary trading desk, in the Institutional Equity Division at Morgan Stanley. A friend of mine on the desk owned $20,000 worth of far OTM November puts on the S&P 500 index. He had bought them in his own personal account. And when the market crashed, those puts that he had bought on a lark for 1/8 each saw their price go to $50 -- 400 times the value of his investment, which was now worth ... $8 million! A wonderful story, right? Now look at it from YOUR side!! Someone was SHORT those puts that Peter had bought! And now, in a flash, some of them were bankrupt and ruined. I saw grown men cry that day. October 19, 1987 -- the day the market dropped 23% in ONE DAY!
So, just make sure you understand what can happen. Not saying it will. But, of all the assets on the face of the earth for which I wouldn't sell an OTM put, bitcoin is probably at the top of the list! A word to the wise. Proceed with caution.
Don
A few comments: with a huge spread such as 168-331, you can always dream of selling the offer or buying the bid, but it is completely unreasonable to think that that is how you will get filled. If, in fact, you did manage to sell the offer, it's because the price of the underlying moved, which changes the dynamic of the spread.
You also have to be aware of what can happen in very volatile times, such as these, and with an incredibly volatile underlying such as bitcoin. Markets sometimes gap, and then don't always give you a chance to react quickly enough to protect your short position. Your write-up above has what we refer to as an "expiration mentality," in that it only considers remaining in the position until expiration. But what if bitcoin gaps down considerably, and before you have time to react, or defend yourself, the price is, say, 4,000, or 3,000, or worse. Now what? Are you still happy to buy it at 5,000 (minus the premium)? Clearly, not.
A quick story. During the crash of October 1987, I was on the index options and futures proprietary trading desk, in the Institutional Equity Division at Morgan Stanley. A friend of mine on the desk owned $20,000 worth of far OTM November puts on the S&P 500 index. He had bought them in his own personal account. And when the market crashed, those puts that he had bought on a lark for 1/8 each saw their price go to $50 -- 400 times the value of his investment, which was now worth ... $8 million! A wonderful story, right? Now look at it from YOUR side!! Someone was SHORT those puts that Peter had bought! And now, in a flash, some of them were bankrupt and ruined. I saw grown men cry that day. October 19, 1987 -- the day the market dropped 23% in ONE DAY!
So, just make sure you understand what can happen. Not saying it will. But, of all the assets on the face of the earth for which I wouldn't sell an OTM put, bitcoin is probably at the top of the list! A word to the wise. Proceed with caution.
Don
Thanks Don. I thoroughly enjoyed reading BJA3.
I am a student of Nassim Taleb's work. Currently rereading Antifragile for the 3rd time. I understand that an OTM Put strategy like this creates potential for a blowup risk. The risk is uncapped while the gain is capped. Taleb seems to be in favor of buying puts or calls with unlimited upside and capped downside. Trades where he will lose over 95% of the time. But when things blow up, he wins big. The strategy I outlined above takes the other side of this trade, so, in theory it would open me up to a massive blowup? Am I essentially doing the opposite and picking up pennies in front of a steam roller?
Thanks again for the wisdom of "proceed with caution". I'm just using "funny money" at this point to validate the strategy. What other strategies would you pursue during these volatile times? I remember reading 10 years ago when I was studying card counting that some of the OG's went to markets to continue their advantage play and receive heat. Do you know any of these guys personally? How did it turn out for them and are they still doing something similar? Sounds like you were trading on the floor, so maybe you were one of the pro's who took their risk management skills to trading. Are those days dead now that there are high frequency algo's doing the trading?
I am a student of Nassim Taleb's work. Currently rereading Antifragile for the 3rd time. I understand that an OTM Put strategy like this creates potential for a blowup risk. The risk is uncapped while the gain is capped. Taleb seems to be in favor of buying puts or calls with unlimited upside and capped downside. Trades where he will lose over 95% of the time. But when things blow up, he wins big. The strategy I outlined above takes the other side of this trade, so, in theory it would open me up to a massive blowup? Am I essentially doing the opposite and picking up pennies in front of a steam roller?
Thanks again for the wisdom of "proceed with caution". I'm just using "funny money" at this point to validate the strategy. What other strategies would you pursue during these volatile times? I remember reading 10 years ago when I was studying card counting that some of the OG's went to markets to continue their advantage play and receive heat. Do you know any of these guys personally? How did it turn out for them and are they still doing something similar? Sounds like you were trading on the floor, so maybe you were one of the pro's who took their risk management skills to trading. Are those days dead now that there are high frequency algo's doing the trading?
"Thanks Don. I thoroughly enjoyed reading BJA3."
Glad you enjoyed.
"I am a student of Nassim Taleb's work."
I'll forgive you.
Currently rereading Antifragile for the 3rd time. I understand that an OTM Put strategy like this creates potential for a blowup risk. The risk is uncapped while the gain is capped. Taleb seems to be in favor of buying puts or calls with unlimited upside and capped downside. Trades where he will lose over 95% of the time. But when things blow up, he wins big.
I really believe that he wrote one way, but, in real life, traded the other way. Virtually all pros understand that selling options is the way to go. It's all I ever did for ten years on the trading desk. Sold strangles on the indexes. Had a motto: "There are only two things you should ever do with an option: sell it or don't sell it!" These are times during which you shouldn't be selling them!
"The strategy I outlined above takes the other side of this trade, so, in theory it would open me up to a massive blowup? Am I essentially doing the opposite and picking up pennies in front of a steam roller?"
Yes and no. Taleb's Black Swans don't come around nearly frequently enough to make selling not a viable strategy. But there is an element of luck involved. If you just arrived for your first day on the trading desk on Friday, October 16, 1987, and you sold strangles, unfortunately, you didn't get to have a second day. You got carried out feet first on Monday! Perhaps ditto for October 2008. But, do you understand that these events occur, what, every 21 years, and then again 12 years later? It isn't lose 95% of the time and win big the other 5%. It's lose 99.9% of the time and win big 0.1% of the time. And that's not enough to make up for the losses.
"Thanks again for the wisdom of "proceed with caution". I'm just using "funny money" at this point to validate the strategy. What other strategies would you pursue during these volatile times?"
Watching other people lose money! I couldn't trade in these times. How can you buy 50-60% volatility (just recently 80-90%!!). Hell, if I wouldn't buy 15-20%, how could I ever buy now? And selling? Fraught with danger. Couldn't ever afford to take your eyes off the screen. Not even to go to the bathroom!
"I remember reading 10 years ago when I was studying card counting that some of the OG's went to markets to continue their advantage play and receive heat."
OG??
"Do you know any of these guys personally? How did it turn out for them and are they still doing something similar? Sounds like you were trading on the floor,"
Wasn't on the floor. Was an "upstairs" trader at MS.
"so maybe you were one of the pros who took their risk management skills to trading. Are those days dead now that there are high frequency algo's doing the trading?"
My style of trading was pretty much legislated out on a lot of the IB's trading desks after 2008 and the Lehman debacle. Very different climate now than when I was trading (1985-95).
Don
Glad you enjoyed.
"I am a student of Nassim Taleb's work."
I'll forgive you.
Currently rereading Antifragile for the 3rd time. I understand that an OTM Put strategy like this creates potential for a blowup risk. The risk is uncapped while the gain is capped. Taleb seems to be in favor of buying puts or calls with unlimited upside and capped downside. Trades where he will lose over 95% of the time. But when things blow up, he wins big.
I really believe that he wrote one way, but, in real life, traded the other way. Virtually all pros understand that selling options is the way to go. It's all I ever did for ten years on the trading desk. Sold strangles on the indexes. Had a motto: "There are only two things you should ever do with an option: sell it or don't sell it!"
These are times during which you shouldn't be selling them!"The strategy I outlined above takes the other side of this trade, so, in theory it would open me up to a massive blowup? Am I essentially doing the opposite and picking up pennies in front of a steam roller?"
Yes and no. Taleb's Black Swans don't come around nearly frequently enough to make selling not a viable strategy. But there is an element of luck involved. If you just arrived for your first day on the trading desk on Friday, October 16, 1987, and you sold strangles, unfortunately, you didn't get to have a second day. You got carried out feet first on Monday! Perhaps ditto for October 2008. But, do you understand that these events occur, what, every 21 years, and then again 12 years later? It isn't lose 95% of the time and win big the other 5%. It's lose 99.9% of the time and win big 0.1% of the time. And that's not enough to make up for the losses.
"Thanks again for the wisdom of "proceed with caution". I'm just using "funny money" at this point to validate the strategy. What other strategies would you pursue during these volatile times?"
Watching other people lose money! I couldn't trade in these times. How can you buy 50-60% volatility (just recently 80-90%!!). Hell, if I wouldn't buy 15-20%, how could I ever buy now? And selling? Fraught with danger. Couldn't ever afford to take your eyes off the screen. Not even to go to the bathroom!
"I remember reading 10 years ago when I was studying card counting that some of the OG's went to markets to continue their advantage play and receive heat."
OG??
"Do you know any of these guys personally? How did it turn out for them and are they still doing something similar? Sounds like you were trading on the floor,"
Wasn't on the floor. Was an "upstairs" trader at MS.
"so maybe you were one of the pros who took their risk management skills to trading. Are those days dead now that there are high frequency algo's doing the trading?"
My style of trading was pretty much legislated out on a lot of the IB's trading desks after 2008 and the Lehman debacle. Very different climate now than when I was trading (1985-95).
Don
Wow. A lot to take in there. (especially when the advice is not what I "wanted" to hear) Thanks Don. I'll take that advice pivot my focus away from trading.
Do you currently follow the macro environment? Based on what you've seen, do you have any sort of guess as to how bad this recession will be?
Based on what I'm reading and learning, I believe it could be a depression. Obviously it depends on how quickly things can start moving again... But it seems like printing money and quantitative easing might not work this time around. Ray Dalio has a very interesting write up of his research posted on LinkedIn. He referenced the long-term credit cycle which he has written about (there's even an animated youtube video) before, as well as how this could potentially be an opportunity for the US to lose dominance and reserve currency status.
Any thoughts, specifically on how to understand the likelihood of the petro-dollar being disrupted?
I am looking at the crazy cheap oil prices (especially if you price in Gold instead of USD) and thinking there MUST be some sort of geopolitical turbulence that comes from this.
Stack on the Pension's being underfunded, and the demographics of all the Baby Boomers retiring and drawing on their assets at the same time...
Things could get wild!
Any advice on where I should spend most of my time and energy? I've currently got a good job that won't be going away (at least within the next year or 2) and have been building an online business on the side. I figure getting a substantial cash position and having no debt will put me in a great spot to pick up some real estate or other screaming good deals that may be available in the future.
Do you currently follow the macro environment? Based on what you've seen, do you have any sort of guess as to how bad this recession will be?
Based on what I'm reading and learning, I believe it could be a depression. Obviously it depends on how quickly things can start moving again... But it seems like printing money and quantitative easing might not work this time around. Ray Dalio has a very interesting write up of his research posted on LinkedIn. He referenced the long-term credit cycle which he has written about (there's even an animated youtube video) before, as well as how this could potentially be an opportunity for the US to lose dominance and reserve currency status.
Any thoughts, specifically on how to understand the likelihood of the petro-dollar being disrupted?
I am looking at the crazy cheap oil prices (especially if you price in Gold instead of USD) and thinking there MUST be some sort of geopolitical turbulence that comes from this.
Stack on the Pension's being underfunded, and the demographics of all the Baby Boomers retiring and drawing on their assets at the same time...
Things could get wild!
Any advice on where I should spend most of my time and energy? I've currently got a good job that won't be going away (at least within the next year or 2) and have been building an online business on the side. I figure getting a substantial cash position and having no debt will put me in a great spot to pick up some real estate or other screaming good deals that may be available in the future.
This is interesting. My understanding is Spitznagel’s Universa Investments (for which Taleb advises) has essentially matched the S&P 500 return over numerous years — annually, not just in total — all while incorporating Taleb’s tail-risk hedging strategies. I’m sure they are doing things more sophisticated than just buying far OTM puts on some small portion of their portfolios, but of course you’ll never find details on that. (I was waiting for you to say Taleb was the $8mm winner in your office!) I agree he seems to be a complete a-hole, or at least that’s his schtick, but I try to not let that completely direct me away from his writing, which I find interesting. I appreciate reading your thoughts on this since I am not smart enough to not be fooled, and the counterpoint is good to consider.
Firstly, I would advise you to forget about the casino, and besides, I don’t understand how gambling can be compared with trading. This is a completely different business. I doubt that there are people who really earn money on gambling, but I know that it is possible. no less, I prefer not to risk and engage in only trading because it is a very cool business. For this I need skills, knowledge and experience. I tried to make money on trading, but I screwed up. After that I found out that my classmate also makes money on trading and in the end, he taught me all his skills. I studied statistics about different companies and this article helped me at https://investotrend.com/most-expensive-stock/. I can’t say that I make a lot of money on this, but this is my main income at the moment.
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Careful with trading Bitcoin (and other cryptocurrencies), like Don mentioned. I'm a big fan of the technology, and believe in its price movement upward long-term, but trying to day or short-term trade on its price is really risky. Since the markets never close (though exchanges can get overwhelmed when things go crazy and end up effectively jammed so no one is able to do anything) and so much of its price movement nowadays is driven by activity in China, you can be happily asleep and wake up to a 25% drop (or rise) due to nothing you could anticipate. People have gotten wrecked over and over trading crypto and it isn't necessarily due to any failed diligence on their part. Crypto just moves fast, hard, and in unexpected ways.
So selling otm puts has absolutely killed it for me since this post started.
I proceed with caution and small limits because I was just learning.
I'd now like to ask you Don about a strategy to get leverage long (without risk??)
--------
Market sell 1 BTC @ 60k
Buy 12/31 ITM calls with .94 Delta or higher
Now I have exposure to 1.9 BTC.
---------
Where did my risk increase? I can sell the calls at any time and I'm buying very far in the money (25k, 30k)
I proceed with caution and small limits because I was just learning.
I'd now like to ask you Don about a strategy to get leverage long (without risk??)
--------
Market sell 1 BTC @ 60k
Buy 12/31 ITM calls with .94 Delta or higher
Now I have exposure to 1.9 BTC.
---------
Where did my risk increase? I can sell the calls at any time and I'm buying very far in the money (25k, 30k)
okay so I did this, so the prices will be slightly lower than they are currently:
Sell 1 BTC for $61.6k
Buy 2.2 BTC worth of 12/31 35k calls for $61.6k
___
My average price was 63k when I sold BTC for 61.6k.
I felt like the biggest risk here would be a short term price correction,
so I also decided to hedge this by taking another 1 BTC and selling for cash then holding in a 8% apy interest account.
__
In total, I Sold 2 BTC.
Used the proceeds of the first sale to buy 2.2 BTC worth of ITM calls
Kept the proceed of the 2nd sales so I can exercise (if needed)
I now have exposure to 2.2 BTC (which I want to sell between now and Dec 2021) PLUS I've pulled out $61.6k cash.
What am I missing? This feels like a free lunch...
And thanks again Don for taking the time to read. I really appreciate it!
Sell 1 BTC for $61.6k
Buy 2.2 BTC worth of 12/31 35k calls for $61.6k
___
My average price was 63k when I sold BTC for 61.6k.
I felt like the biggest risk here would be a short term price correction,
so I also decided to hedge this by taking another 1 BTC and selling for cash then holding in a 8% apy interest account.
__
In total, I Sold 2 BTC.
Used the proceeds of the first sale to buy 2.2 BTC worth of ITM calls
Kept the proceed of the 2nd sales so I can exercise (if needed)
I now have exposure to 2.2 BTC (which I want to sell between now and Dec 2021) PLUS I've pulled out $61.6k cash.
What am I missing? This feels like a free lunch...
And thanks again Don for taking the time to read. I really appreciate it!
Would rather not look at anything involved with crypto, but thanks anyway.
When you buy deep ITM calls and sell the underlying against them in equal number, you basically have simply bought synthetically a far OTM put, which is practically worthless. But, if you do all the legs at once, you shouldn't be able to get it for free, so you "legged" into this position, which means you didn't do everything at the same time, and the prices worked out for you so that there is no debit.
So, you appear to have two free puts, which aren't going to be worth very much, unless bitcoin crashes, and then 0.2 of the deep ITM 35 call, which obviously will have some value.
Don
When you buy deep ITM calls and sell the underlying against them in equal number, you basically have simply bought synthetically a far OTM put, which is practically worthless. But, if you do all the legs at once, you shouldn't be able to get it for free, so you "legged" into this position, which means you didn't do everything at the same time, and the prices worked out for you so that there is no debit.
So, you appear to have two free puts, which aren't going to be worth very much, unless bitcoin crashes, and then 0.2 of the deep ITM 35 call, which obviously will have some value.
Don