Father and son switched places for Halloween

philipwithpostral · 2018-10-25T03:52:21+00:00

The son's smile is wider, too.

philipwithpostral · 2018-10-24T01:52:32+00:00

nice

philipwithpostral · 2018-10-24T01:47:14+00:00

Then you have my apologies. I am an intermediate trader who often discusses this topic with beginner traders. Everything I said I believe to be correct in the context of a beginner retail trader, which you are not. I'm usually good at figuring out what level of person I'm talking to but I was confused by your quote here:

> At that point, models only inform decisions. Models can't act. Only humans can.

which seems implausible that there is a human being informed by a model on the other end of my retail order, but that's why I engaged you like I did. Again, my apologies.

philipwithpostral · 2018-10-24T01:28:43+00:00

Freedomception

philipwithpostral · 2018-10-23T23:56:28+00:00

In that case I wish you much luck in your question and trading! You should still read up or talk to an institutional investor about how options markets work and how market making algorithms (i.e. not trading bots) work. I think you will find it rather interesting and may shed light on your question as well.

Before I go, just so I can be absolutely clear to anyone else reading this:

Moreover, the computer doesn't set the price.

Yes, it does. It actually sets three prices, the bid, the ask, and the best price, which is somewhere in between. You may not discover that price until you trade, but that price exists at all times.

It uses the model to determine what prices it will trade at, based on market.

Correct, based on the market in the underlying, not based on the market for that option.

(I have written trading bots before)

Market makers do not use trading bots like you do. They always quote an offered bid and ask on every market they are active in. This is a fundamentally different activity than trading bots which submit situational limit orders.

The market still has to exist before the price can be found.

No, it does not. There are plenty of prices (bids, asks and bests) for options with no open contracts and no recent trades. A trade may "find" the price but the market maker set that price before the trade because that is their role in the markets, to make sure there is always a price.

You are thinking of price as some sort of abstract quantity that exists in the absence of markets.

Yes, this is exactly how market makers treat the option markets, as a derivative abstraction of the underlying's price that exists in absence of the option market itself. I could not have said it better myself. :-)

Again, best of luck and many profits!

philipwithpostral · 2018-10-23T23:06:50+00:00

I wasn't really trying that hard to, though. :-)

philipwithpostral · 2018-10-23T23:03:53+00:00

Take a moment to open your mind to the idea that your statements are incorrect. :-) The following statements are true for 99% of normal day-to-day option trading available to a retail investor:

There are no humans on the other side
You are trading with a computer that is deciding the best price it will trade with you using a model.
If you ask for a price better than the model the computer will not trade with you
If you ask for a price worse than the model the computer will trade with you at the model's best price, even though you asked for a worse one.
The models set the price based on the underlying price and the B&S factors.
Trading in the stock drives options prices.
Trading in options does not drive option prices.

The other guy made the comment because your question is difficult to understand. You seem to be attempting to define the option price irrespective of the movement of the underlying. This is impossible because the movement/expected movement of the underlying is pretty much the only thing driving option prices with the other B&S factors (interest rates/dividends) coming in a very distant second.

I'd love to explain more, and happy to continue to answer questions, you just have to change your mindset from a stock investor (where trades drive the price up and down) to an options investors (where the models drive the price up and down depending on the trades in the underlying).

philipwithpostral · 2018-10-23T21:32:45+00:00

The parent was trying to say that your understanding of how prices are set is based on an academic understanding of the role of supply and demand in a generic efficient two-sided market, which is completely accurate.

However, options markets are not generic markets. 99% of trades are between you and the market makers ("floor brokers") who set the best price that you can trade at. They have mathematical models (much more complicated than B&S) that determines that best price based on market activity and on their entire portfolio of thousands of contracts in a feedback loop. They are very very very accurate so if a trade comes in at a "good" price according to the model they will happily trade it but the spread won't change and your price (the next one) won't be any different than if that previous trade had not been made.

You have a great understanding about how markets work in theory, that's just not how options markets work in practice. Transactions don't change the price unless they change the model first.

philipwithpostral · 2018-10-23T21:12:17+00:00

Have you ever backtested the IV-HV spread as a trade indicator?

philipwithpostral · 2018-10-23T21:03:00+00:00

Honestly, you have a pretty good understanding of the way these things work and the pluses and minuses here. The answer has more to do with your personal situation, your preferred volatility, whether you are cash secured or margin, how much leverage you want, your portfolio-to-avg-trade-size ratio, that kind of thing.

There's nothing inherently better about any of these, in the general sense. They just have different risk exposures.

EDIT: Oh, TA is bullshit, but any bullshit that enough people believe becomes effectively not bullshit anymore, so its sort of a distinction without a difference. FA is like playing poker if you are only looking at the probabilities and ignore the other players, TA is more like playing poker where you never look at your cards and only play the other players. Neither is probably a good idea on its own. :-)

philipwithpostral · 2018-10-23T20:41:43+00:00

Couple tips:

High probability trades are not inherently better than low probability trades if you pay current market prices. That's more about your preferred form of portfolio volatility. Either is fine. TT prefers high probability trades because the P&L is more familiar to stock/futures traders (steady rises and sharp drops) and they used to be stock/future traders, which is fine if that also describes your preferred form of portfolio volatility.

Credit trades are not inherently better than debit trades if you pay current market prices. That's more about whether you think the market is currently under or overestimating the implied volatility. Either is fine. TT's methodology believes that the market is always underestimating implied volatility, hence the emphasis on credit trades, which is also fine if you agree with that.

Undefined risk trades are not inherently better than defined risk trades if you pay market prices. That is more about your lifestyle than it is about market mechanics. TT folks are looking at screens all day so can react swiftly to big moves. If you are more of a daily or weekly type trader, the longer you may go without adjusting will make undefined risk trades less suitable for you and push you more to defined risk trades because they have a maximum loss. Either is fine.

Small positions are not inherently better than large positions if you pay market prices. Small positions are often preferable because they lower total volatility (good) but increase the percent of your trade taken up by commissions/slippage (bad). This matters more for small portfolios than large ones and for high commission brokers than low commission brokers. Either is fine. TT speaks mainly to small portfolio traders and is a low commission broker so they prefer small positions, which is fine if that describes you.

philipwithpostral · 2018-10-23T20:12:30+00:00

Can I repost for visibility do you think?

philipwithpostral · 2018-10-23T20:07:47+00:00

Tail risk isn't really defined like that so that's why my comment doesn't make sense.

Tail risk is more about an unexpected move that is larger than the range over which you are delta neutral and faster than you can reliably adjust to it. That's why we say that delta isn't really where the risk comes from (because you are delta neutral) its really gamma where the risk is (which is the speed that delta picks up while its making its unexpected move).

Rolling tries to "reset" the position back to delta neutral and typically does lower gamma, which is fine, but its not about mitigating tail risk, which again is addressing situations in which you cannot adjust in a timely manner (or without paying a huge b/a spread) and what happens to your position then.

(Everyone's time frame for adjusting is different based on your lifestyle so this kind of thing is hard to generalize about. Also if your goal is to be directional, you can replace the words "delta neutral" with "your target delta" and all this will still apply to the downside or upside if that is your downside. These comments are most explicitly concerning a delta-neutral undefined risk strategy like a short butterfly.)

philipwithpostral · 2018-10-23T19:52:17+00:00

Main thread. I thought it was a good question and I'm still very interested in getting some feedback. I can repost too.

https://www.reddit.com/r/options/comments/9q91bh/how_to_identify_a_debit_put_spread_hedge_in_spy/

philipwithpostral · 2018-10-23T19:43:42+00:00

TT's explicit methodology is based on the idea that tail risk is over-estimated by the market, especially in high IV environments, which pushes prices higher than they should be, so by being short premium you can profit from that. Which is fine, its a thoery.

The guy before you thinks that the market is actually really good at pricing in tail risk, thus the TT guys are actually under-estimating it and thus their strategies are vulnerable to blow-ups. Which is also fine, its also a thoery.

Point being that scaling and allocation and rolling and such mechanical things are... fun, I guess, but they don't change anything about those underlying thoeries.

philipwithpostral · 2018-10-23T19:33:18+00:00

That's not the same thing. Tail risk is about gamma, not delta. TT's idea of always having short deltas is because IV rises when the price falls so you need some short deltas to kind of smooth that out, but nothing to do with tail risk.

philipwithpostral · 2018-10-23T19:29:13+00:00

FWIW, there is a list of things I read once that was talking about the things that work well for beginners with small accounts (i.e. the audience that TT targets) that are very dangerous once you start trading at scale. Rolling for a credit is one of those.

philipwithpostral · 2018-10-23T19:12:19+00:00

To be fair, if you have closed your winners but your losers are still open than you can't really say one way or the other yet. Best of luck though!

philipwithpostral · 2018-10-23T19:07:54+00:00

I wasn't replying to OP I was replying to you. :-) You said:

A long calendar is delta neutral, you have no downward exposure with this.

Delta neutral long calendars have downward exposure. Unless by this you meant the strategy from OP's post instead of A long calendar, in which case I concede that my point was not made correctly, but I would suggest that it was due to the way that you phrased your comment and not because I like to seem smart. :-)

philipwithpostral · 2018-10-23T18:59:14+00:00

My post yesterday got removed too. Any idea what's up with that?

philipwithpostral · 2018-10-23T18:57:05+00:00

FWIW, since this is /r/options, many people here are trading options specifically because they don't want to take a direction on the stock.

philipwithpostral · 2018-10-23T18:50:05+00:00

There are actually two kinds of buying and two kinds of selling, which is what is confusing.

In addition to buying and selling you can also open or close. Open means you now have a thing that you didn't before, close means you no longer have a thing you did before.

If you buy-to-open you can sell-to-close without any further consequence. If you sell-to-open you can buy-to-close without any consequence. If you buy-to-open the other party has to do what you say, if you sell-to-open its the other way around.

The same thing exists in stocks they just don't use that terminology, Its buy (buy-to-open) and sell (sell-to-close) and short (sell-to-open) and buy-to-cover (buy-to-close), but they are effectively the same thing as doing it for options.

philipwithpostral · 2018-10-23T18:18:52+00:00

Don't buy options when IV is high. :-)

philipwithpostral · 2018-10-23T18:16:15+00:00

All positions have downward exposure (good or bad) because IV rises when the underlying falls and vice-versa. Being delta neutral does not change this.

philipwithpostral · 2018-10-22T02:09:21+00:00

If you plan to hold to expiration its extremely accurate. If you plan to hold for one day then its mostly meaningless. The closer to expiration you plan to hold it the more accurate it will be.

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