# Long Volatility as an Investment



## wayneL (10 November 2020)

Those of us involved with options are aware, or should be, about the intrinsic vector of the pricing of volatility.

A few months ago I briefly mentioned the investment strategy known as the Hawk and The Serpent, as proposed by Chris Cole of Artemis Capital

Chris' thesis is having a strategic allocation of capital roughly 25% as long volatility.

Others such as Nick Taleb I have also employed a similar thesis with success.

Those of us in the optionosphere know long volatility as being long Vega, but what does this mean in practical terms?

The most basic manifestation of long vega is being long puts on a portfolio, however simply being long puts it's a tremendous drag on portfolio performance when the market is in a extended bull phase.

Like insurance, it costs money... And depending on how you structure it, that cost may be prohibitive.

So has an intellectual exercise I think it would be an interesting discussion to explore how one may become "long volatility", without having to time volatility events... How one may construct volatility into a long-term portfolio.

I have some ideas, but over to you guys, what do you think?


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## cutz (11 November 2020)

Interesting discussion mate.

Firstly I need to have a look at the strategy you discussed, a link would be great, I've had to throttle back at the moment due to events in my life.

Couple of points on the fly, long volatility has to be on at all times, this takes some huge discipline and patience, something I'm a little short of.

Little example of mine, back at the start of the year I was actually long volatility, there was talk of the virus and I had accumulated long index puts, remnants of previous strategies plus more, with almost perfect precision I closed out to cash what little extrinsic value was remaining then the market finally plunged, I spent months thinking about what could have been !

Back to topic,  index backspreads look good on paper but  I never had any real success with these, how about call spreads against your holdings using the credit to buy WTFOTM index puts, robotic like discipline required to ensure those puts are always on ?


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## wayneL (11 November 2020)

@cutz search "hawk and serpent Chris Cole" on yoootooob and it will bring up several interviews and analyses regarding Chris Coles thesis and various ways of being long volatility in a portfolio.

That's the best way, I just don't have a single link that encapsulates the whole thing.

For The longest time, Taleb has been trading a similar idea, though I think a little bit more simple approach. You are right that it does require patience, volatility explosions seldom happen.

I think this is why Cole's thesis is to keep it as only part of a portfolio.... IIRC, 25% Bonds, 25% Equities, 25% precious metals, and 25% long vol. (Personally I would shoehorn some bitcoin in there somewhere, perhaps in the precious metals allocation?)

The idea seems to be that when everything else is blowing the **** up, as we saw earlier this year, the long volatility and the positive gamma will offer a substantive hedge and possibly even a nice little profit centre.

The trick is in constructing it so that it does not whiteant returns in the meantime. I think long dated back spreads fit the bill here, readjusted at appropriate times.

2, 3, 4...... 10 sigma events tend to happen too quickly for we mere mortals to be smart asses and trade to advantage. At least it is for me, extreme volatility is difficult to trade in my opinion.

That strategic long vol position could just be the thing having us kicking back, pouring a nice glass of Shiraz and just watching everything unfold with a smile on our face.


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## cutz (11 November 2020)

Hi Wayne.

Found a macro voices you tube from back in Feb when talk of the virus was in its infancy, had to bail at 10min due to other committments, I'll get back to it tonight, it's around one hour long.

Your back spread idea ok, especially if it can be done for a credit, I do recall you have success with these, trick is staying out of the hole heading into expiry, normally I manage to fail.

You expecting something in the near term ? The vaccine rally is making me nervous..


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## chips88 (11 November 2020)

I believe there is also an allocation to commodity trend in the portfolio. With roughly 20% allocations on each asset class?

I am also in the search for what long volatility is as an asset class, its hard to get the head around and there is not much info online about what strategy's to use, but I have come across using an options straddle strategy, which basically profits on any large move of the underlying, in any direction it ends up going.

From what I can gather it is a slow bleed on your account but when it pays off in times of crisis, or bubble for that matter, it pays off big.

Full disclosure, I have never traded options and am only going off what I have read from papers online like Chris Coles one.


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## wayneL (11 November 2020)

chips88 said:


> I believe there is also an allocation to commodity trend in the portfolio. With roughly 20% allocations on each asset class?
> 
> I am also in the search for what long volatility is as an asset class, its hard to get the head around and there is not much info online about what strategy's to use, but I have come across using an options straddle strategy, which basically profits on any large move of the underlying, in any direction it ends up going.
> 
> ...



Yes you are correct, I had completely forgotten about the commodity trend trading allocation.

Straddles/strangles are indeed long vol, but the vega  pump effect is asymmetric 99% of the time, Hence why, until some smarty comes up with a better solution, I am thinking about long dated put back spreads.

If the world turns to ****, you get the benefits of both +Vega and +gamma.

If wall street is overdosing on methamphetamines, your long equities are raking it in, and your put back spread comma depending on vols at the time and how you construct it, is essentially breaking even or there abouts... Perhaps even modestly profitable.

If you find yourself in the valley of the shadow of death, you can just wait it out for a move, or restructure. This is the advantage of long dated structure, dodging the majority of theta.


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## wayneL (11 November 2020)

cutz said:


> Hi Wayne.
> 
> Found a macro voices you tube from back in Feb when talk of the virus was in its infancy, had to bail at 10min due to other committments, I'll get back to it tonight, it's around one hour long.
> 
> ...



My thesis is that there's going to be a bukkake of liquidity... They are going to try to inflate their way out of this, so I don't anticipate any sort of stock market crash anytime soon (EVEN IF IT SHOULD).

But.... Chaos theory.... a butterfly flapping its wings in San Francisco can cause a tempest in Tokyo... So who the hell knows, a six sigma event could happen at any point.


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## Value Collector (11 November 2020)

wayneL said:


> @cutz search "hawk and serpent Chris Cole" on yoootooob and it will bring up several interviews and analyses regarding Chris Coles thesis and various ways of being long volatility in a portfolio.
> 
> That's the best way, I just don't have a single link that encapsulates the whole thing.
> 
> ...



I pretty much have the exact opposite take to Chris, I am about 20% realestate, 5% fixed interest, 70% equites and I operate a largish short put portfolio.

may the moment some of the companies I feel very strong about such as FMG are selling out of the money puts at at rates of over 18% at an annual rate, that is super expensive insurance in my opinion, when insurance is that pricy I prefer to be the seller rather than the buyer.


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## cutz (11 November 2020)

wayneL said:


> My thesis is that there's going to be a bukkake of liquidity... They are going to try to inflate their way out of this, so I don't anticipate any sort of stock market crash anytime soon (EVEN IF IT SHOULD).
> 
> But.... Chaos theory.... a butterfly flapping its wings in San Francisco can cause a tempest in Tokyo... So who the hell knows, a six sigma event could happen at any point.




@wayneL , I am actually in the process of simplifying my portfolios, the past week has enabled me to fast-track the process, XJO backspreading is something I would like to have another look at, looking at the Feb 6000/5700 puts 1:2 ratio can be done for zero cost, if vols continue to collapse maybe a credit, I've also got some leftover long puts expiring Nov and Dec, I'll resist the urge to close these out for a pittance.


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## cutz (11 November 2020)

Value Collector said:


> I pretty much have the exact opposite take to Chris, I am about 20% realestate, 5% fixed interest, 70% equites and I operate a largish short put portfolio.
> 
> may the moment some of the companies I feel very strong about such as FMG are selling out of the money puts at at rates of over 18% at an annual rate, that is super expensive insurance in my opinion, when insurance is that pricy I prefer to be the seller rather than the buyer.




He has an extremely dim view on buy write and naked put strategies, I learnt the hard way with covered calls, selling out upside is a nice way of putting it.


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## Sharkman (11 November 2020)

i would imagine that simply buying calls or puts (or both) outright and constantly maintaining that position by buying more to replace the previous ones when they expire is not sustainable in the long run, your capital just gets gradually eaten up by decay, and you're basically relying on a huge blowup happening sometime for it to make money. if it's considered as a form of "insurance" it's probably ok, but if it's considered as an "investment", it's a crapshoot.

IMHO it'd be hard to make that even sustainable, let alone profitable, if one is constantly buying options straight up in a monotonous manner and simply paying the decay. even if buying longer dated options, say 1 year + (assuming liquidity/spreads aren't an issue, but they will be if considering Aust options) to reduce the decay, in a low vol environment the tenor skew tends to slope upwards in anticipation that the "tranquility" can't last forever, so you probably don't even get the full benefit of that low vol environment when going long dated. and that's a lot of premium to outlay if buying long dated options in a high vol environment.

which probably necessitates having to find a way to defray the cost of the bought premiums somehow. roll the dice on a calendar/diagonal and try to get the back leg to "on the house" status, netting you "free protection" until it expires, and hope that you don't get caught with your pants down if it gaps thru the support/resistance levels that you based the front leg on before the front leg rolls off? or don't maintain the protection constantly, but instead only use it strategically at points where you feel the rest of the portfolio needs the protection, and fly unhedged the rest of the time? that all needs some element of timing though.

maybe i've been looking at it the wrong way. you said long vol, but not necessarily long gamma/short theta. so maybe something wacky like a ratio diagonal might do the trick, where you buy a certain number of longer dated OTM calls/puts netting a lot of vega, then keep selling a smaller number of shorter dated ATMs against it to neutralise most/all of the gamma/theta while keeping most of the vega? possibly then salt to taste by buying/selling underlying if one wants to be delta neutral as well?

don't really know, just theorycrafting here as i've never tried shooting for a pure +vega position in an actual trade before. seems like a lot of effort to have to constantly square up the risks you don't want to leave only the one risk that you do want, so transaction costs (plus the cost of your own time, which shouldn't be forgotten) are a factor here. and would probably need a good understanding of how the delta and tenor skews behave under various conditions (eg. before/after earnings reports, macro stuff like interest rate moves etc.) for the chosen underlying, if the skew does the opposite of what you want, that probably wrecks this sort of strategy.

i'm primarily a covered call/cash covered put seller though, so not all that familiar with the nuances of vol plays, i don't really make them very often. keen to hear how other traders would approach this sort of scenario, i definitely have a lot to learn in this area.


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## cutz (11 November 2020)

wayneL said:


> My thesis is that there's going to be a bukkake of liquidity... They are going to try to inflate their way out of this, so I don't anticipate any sort of stock market crash anytime soon (EVEN IF IT SHOULD).




Yep,

The amount of irrational exuberance in this week's market is extraordinary, not something I wanna bet against ( as in delta 1 index shorts ), the vaccine was just the trigger for a whole load of backdriving !


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## wayneL (12 November 2020)

Value Collector said:


> I pretty much have the exact opposite take to Chris, I am about 20% realestate, 5% fixed interest, 70% equites and I operate a largish short put portfolio.
> 
> may the moment some of the companies I feel very strong about such as FMG are selling out of the money puts at at rates of over 18% at an annual rate, that is super expensive insurance in my opinion, when insurance is that pricy I prefer to be the seller rather than the buyer.




One must understand what is trying to be achieved with the dragon portfolio. Short volatility such as covered calls and short puts is a completely different approach, which should rightly be discussed on a different thread to this. 

The Dragon portfolio is intended to be a strategy which is implemented and maintained on a lifelong basis, perhaps even multi-generationally.

What we are specifically talking about with this aspect of the dragon portfolio ie long volatility, is tail risk. The dragon portfolio is nothing less than a true personal hedge fund, in its original sense.

Net short options exposes you to tail risk, long volatility strategies hedge against and/or benefit from multi-sigma events.

If you are short puts whether that is synthetic or not, the world turning to merde is a cause for extreme panic and quick action to keep you out of the bankruptcy courts.

Long vol means you can order another pina colada, sit on the beach improving your suntan and enjoy watching everybody else sh17 themselves.

In theory anyway. 

If you can construct it with enough gamma, and in conjunction with other aspects of the portfolio you may even be able to put a deposit on the Roller and the digs in St Bart's nextdoor to Hugh Hendry.

We want to be Eclectica, not LCTM


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## Value Collector (12 November 2020)

wayneL said:


> One must understand what is trying to be achieved with the dragon portfolio. Short volatility such as covered calls and short puts is a completely different approach, which should rightly be discussed on a different thread to this.
> 
> The Dragon portfolio is intended to be a strategy which is implemented and maintained on a lifelong basis, perhaps even multi-generationally.
> 
> ...




yep, I understand the strategy, it’s basically taking some of the cash generated from other sources (or capital) and using it to buy insurance against a negative event in the future.

like all insurance, it’s smart at one price and silly at another, and just like insurance you can make it cheaper by accepting a larger excess.

thats why I mentioned at certain prices I would rather be selling insurance.

As I said 3 days ago I saw that out of the money put options on a share I follow we’re selling for over 18% of the strike price on an annual basis, from an insurance perspective, that means after roughly 5 years the put option seller would have collected the entire strike price as premiums, and the stock price could go to $0 and he would still break even.

of course cheaper options could be purchased deeper out of the money, but the person seeking insurance is essentially accepting a larger excess payment and reducing the number of times this policy will be profitable.

———————

It all comes down to margin of safety, if some one is going to take on a life time or multi generational insurance policy, where they are paying out regular fees to counter parties, they have to be sure that those fees make sense compared to how often the events occur in which their policy is triggered.


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## wayneL (12 November 2020)

Value Collector said:


> yep, I understand the strategy, it’s basically taking some of the cash generated from other sources (or capital) and using it to buy insurance against a negative event in the future.
> 
> like all insurance, it’s smart at one price and silly at another, and just like insurance you can make it cheaper by accepting a larger excess.
> 
> ...



"Insurance", though essentially how options are priced via Black Scholes, Binomial, etc, is not how we are looking at this in this instance and I will raise two overarching points.

1) Expensive may be cheap and cheap may be expensive.

Let's say you pay a crapper load for long puts and your market tanks 75%. The price you paid was cheap. On the other hand if you pay a pittance and it continuously expires out of the money, it is expensive.

Implied and realised volatility scarcely matches in the real world in real time.

Again, I will cite LCTM. Expensive or cheap can only truly be determined in hindsight

2) Simple short or long options does not represent the strategy being proposed here, in general.

Such an approach is, at its core, is trading theta against delta/gamma, whether such is + or -.

Being strategically long volatility is, at it core, trading vega/gamma, with both being +, theta being largely hedged out.

Long vol does not require hindsight, merely an understanding of kurtosis and fat tails 

These two things are profoundly different.


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## Value Collector (13 November 2020)

wayneL said:


> 1) Expensive may be cheap and cheap may be expensive.
> 
> Let's say you pay a crapper load for long puts and your market tanks 75%. The price you paid was cheap.



As a one off speculation you would make money, how ever as a life long policy you definitely lose.

let’s look at an over simplified example.

lets say we were both in our early 20’s and had both just inherited $1 Million each from grandpa.

lets you wanted to invest your $1 Million is the ASX 200 index which is sitting at 6000 points, because you thought that might grow in value over time, but you wanted to insure your self against that 75% fall that might happen one day.

fortunately for you I offer to sell you insurance, All I ask is that each year you give me all your dividends on your $1 Million of asx200 index, and I will promise to ensure your portfolio never drops below your $1 Million starting level.

short term this bet might work out for you, but the longer you continue paying me your dividends, the more cash I accumulate until eventually I have a kitty with well over your $1 Millon insured sum.


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## ducati916 (13 November 2020)

Value Collector said:


> As a one off speculation you would make money, how ever as a life long policy you definitely lose.
> 
> let’s look at an over simplified example.
> 
> ...





I believe that you misunderstand the issue from reading your example above. Staying with your example and adding 1 further assumption: that the market will show 10% compounded annual growth.

Wayne is not seeking insurance for his $1M, he is seeking insurance for 100% of his gains going forward. That is a very different proposition. So in 10yrs time you are insuring not $1M but $2.6M.

jog on
duc


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## Value Collector (13 November 2020)

ducati916 said:


> I believe that you misunderstand the issue from reading your example above. Staying with your example and adding 1 further assumption: that the market will show 10% compounded annual growth.
> 
> Wayne is not seeking insurance for his $1M, he is seeking insurance for 100% of his gains going forward. That is a very different proposition. So in 10yrs time you are insuring not $1M but $2.6M.
> 
> ...



If you are assuming 10% compounded growth, then you must also factor in the increased lost potential of the money you paid out as insurance premiums.

eg, all those dividends you paid out to me as insurance premiums could have been reinvested at 10% compounded growth for you however instead you paid them to me. And the dividends them selves would have grown rising the premiums I charged.

———————-

Also, in reality the entire $1 million or even the $2.6 Million is not really at risk, since the index will never go to zero.


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## ducati916 (13 November 2020)

1. If you are assuming 10% compounded growth, then you must also factor in the increased lost potential of the money you paid out as insurance premiums.

2. eg, all those dividends you paid out to me as insurance premiums could have been reinvested at 10% compounded growth for you however instead you paid them to me. 

3. And the dividends them selves would have grown rising the premiums I charged.

———————-

4. Also, in reality the entire $1 million or even the $2.6 Million is not really at risk, since the index will never go to zero.


1. Incorrect. Those are being paid to you as 'insurance'. The 10% growth rate earned are purely capital gains on the initial $1M.

2. They could have been, but were not, because I took out insurance against tail risk. I transferred for that premium, all my risk to you. The insurance model is of course that you take those premiums and invest them, growing them so that if a claim is made on an expanded capital base, that you have the capital to pay my claim. The issue (for you) is that you need to meet or exceed my 10% capital growth rate p/a while concurrently hoping that any claims come later rather than earlier.

3. In some cases yes, in some cases no. That is an additional issue (risk) for the insurer.


However your example does not actually reflect the reality of the position, vis-a-vis selling Options. Options are a leveraged instrument. You are picking up pennies in profit while assuming dollars of risk in losses, hence the LTCM argument already put to you. This is relevant to your point [4]: the market does not need to go to zero to have you carried out on your shield: 22% on 19 Oct. 1987 was more than adequate to bankrupt you. More recently, this past Feb. and COVID.

@wayneL is arguing in this thread that, as a buyer of vol. you spend pennies to pick up dollars. It is psychologically an unpleasant way (although very effective) to profit from the market.

The issue for this thread is: how do you minimise your costs (losses) and maximise the returns (profits) on this model?

jog on
duc


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## Value Collector (13 November 2020)

ducati916 said:


> 1. If you are assuming 10% compounded growth, then you must also factor in the increased lost potential of the money you paid out as insurance premiums.
> 
> 2. eg, all those dividends you paid out to me as insurance premiums could have been reinvested at 10% compounded growth for you however instead you paid them to me.
> 
> ...




since when has the market averaged 10% compounded growth excluding dividends? Especially over a life time as in Wayne’s example.

and as I said at the moment some stocks “insurance premiums” are selling for over 18%, so at that price even your 10% growth factor is dwarfed by the Premiums you are paying out.

I don’t think picking up annualised premiums of 18% of the insured value is the same as “picking up pennies”

—————
as for insuring an increasing capital base it works both ways.

the capital base would have to drop 18% in the first year to break even, if it only dropped 10% you lost, and the insurance in the second year would be based on the lower capital base.


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## ducati916 (13 November 2020)

1. since when has the market averaged 10% compounded growth excluding dividends? Especially over a life time as in Wayne’s example.

2. and as I said at the moment some stocks “insurance premiums” are selling for over 18%, so at that price even your 10% growth factor is dwarfed by the Premiums you are paying out.

3. I don’t think picking up annualised premiums of 18% of the insured value is the same as “picking up pennies”

—————
as for insuring an increasing capital base it works both ways.

4. the capital base would have to drop 18% in the first year to break even, if it only dropped 10% you lost, and the insurance in the second year would be based on the lower capital base.

1.







2. But as already indicated, your example isn't what the thread is actually discussing. You have missed the point. So let's take a real example from today's prices:









So you are selling a PUT just OTM at strike $353.00

The following applies:








4. Incorrect.

So you will pocket $9.30.

The market falls 10%






$35.49 - $9.30 = (-$26.19). You have just lost x3 your money. A real outlier, oh, 2020 and 30%...






Now your loss is (-$96.77). That is x10 your money. See how declines are not proportional to your losses?

3. I do.

Now that is an index. Do that on individual stocks, which are more volatile than an index and your are playing with a significant amount of risk, seemingly without really understanding what you are actually doing.

jog on
duc


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## wayneL (13 November 2020)

@Value Collector So long as the gamma monster doesn't catch you.

To repeat once again, the same beast that ate LCTM.

But that's off topic, the topic here is *long volatility* as a strategic aspect of a total portfolio.

Long theta/short gamma is a whole 'nuther bowl of wax.


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## wayneL (13 November 2020)

... short gamma is also what ate Nick "the wonder boy" Leeson and bankrupted Barrings Bank.

As such, it is absolutely antithetical to the topic at hand.


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## Value Collector (13 November 2020)

ducati916 said:


> 1. since when has the market averaged 10% compounded growth excluding dividends? Especially over a life time as in Wayne’s example.
> 
> 2. and as I said at the moment some stocks “insurance premiums” are selling for over 18%, so at that price even your 10% growth factor is dwarfed by the Premiums you are paying out.
> 
> ...




Ok,  you are confused.

That table that you put up showing a 9.43% return since 1982, includes dividends of about 6% which as I said those dividends would have been spent on premiums, the 12.09% is reinvesting and compounding those dividends, So like I said the capital gain excluding dividends is much lower than 10%.

Secondly when I said some shares cost over 18% to insure I was talking about FMG, as of 11am today the market is as follows

FMG share price $16.81,.... Cost for a $16.50 Jan put option = circa 82 cents, thats for 2 months protection, so if you were selling that put every 2 months that would cost you $4.92 for the year, thats about 30% of the insured value paid as premiums over the year, even if you bought 6 moths cover you are still paying 20%+ as premiums, and that for out of the money options

That is why I said when insurance is so expensive, I much prefer to be selling insurance rather than buying it, good luck hoping to out run insurance premiums of 30% or 18% by capital gains over time, hell unless the drop is fairly sudden the premiums collected are likely to dwalf any permanent drop in the future,.


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## ducati916 (13 November 2020)

Ok,  you are confused.

1. That table that you put up showing a 9.43% return since 1982, includes dividends of about 6% which as I said those dividends would have been spent on premiums, the 12.09% is reinvesting and compounding those dividends, So like I said the capital gain excluding dividends is much lower than 10%.

2. Secondly when I said some shares cost over 18% to insure I was talking about FMG, as of 11am today the market is as follows

3. FMG share price $16.81,.... Cost for a $16.50 Jan put option = circa 82 cents, thats for 2 months protection, so if you were selling that put every 2 months that would cost you $4.92 for the year, thats about 30% of the insured value paid as premiums over the year, even if you bought 6 moths cover you are still paying 20%+ as premiums, and that for out of the money options

4. That is why I said when insurance is so expensive, I much prefer to be selling insurance rather than buying it, good luck hoping to out run insurance premiums of 30% or 18% by capital gains over time, hell unless the drop is fairly sudden the premiums collected are likely to dwalf any permanent drop in the future,.

1. That table is merely to demonstrate that circa 10% (excluding dividends) was available. You doubted that 10% was available. That of course is an index of 500 stocks. 

2. Let's stick with your FMG, even though it has nothing to do with the issue in this thread. So:






And the chart:






A possible (lower) price: $12






So for your $0.87 premium, you lose $3.78.

4. Aren't all drops sudden?

jog on
duc


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## Sharkman (13 November 2020)

ducati916 said:


> $35.49 - $9.30 = (-$26.19). You have just lost x3 your money. A real outlier, oh, 2020 and 30%...
> 
> Now your loss is (-$96.77). That is x10 your money. See how declines are not proportional to your losses?




that's all true, but that's only evaluating a single month in isolation, the strategy has to be evaluated over the longer timeframe. it's a bit of a stretch to selectively pick and choose which months you'll buy protection and which months you won't, because you don't reliably know in advance which month the 10% blowup will occur in, nobody does. you don't insure your house just for January and leave it uninsured the rest of the year. and if you adopt the approach of waiting for signs of a potential blowup before taking out the protection, the IVs will have already risen by then making the premiums drastically more expensive.

if the blowup happens a year into the strategy, assuming constant vols the put seller will have already collected *$93* in premiums, minus whatever is lost in the months where the options only expire slightly ITM. there's a decent chance that's going to be more than $35.49.

even if the blowup happens in the first month, the put seller is temporarily down $26.19, but if sufficiently collateralised so that one month doesn't knock them out, they can make it back over the coming months, as the market just does not fall by 10% a month for several months in quick succession, in the same way that you don't have disasters requiring you to claim on your home insurance month after month (if you do, i'd suggest maybe moving somewhere else?)


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## Value Collector (13 November 2020)

ducati916 said:


> So for your $0.87 premium, you lose $3.78.
> 
> 4. Aren't all drops sudden?
> 
> ...




There is only 2 months until the Jan contracts expire, not 3.

and as Sharkman pointed out, you selectively assuming this sudden drop happens within the first 2 month period, which's I said if it happened would result in a good speculative gain, but as longterm strategy, paying 30% per year of an assets capital value is probably no going to be wise, because you are counting on a shorter sudden drop, if that doesn't happen you will be bleeding capital.

I will happily sell you insurance on FMG stock at $16.50 for 40 cents per share each month for the rest of your life if you think its a great deal, I would suddenly have a great little synthetic FMG portfolio paying $4.80 in dividends per year, that a synthetic 29% dividend yield for me, and I didn't even have to buy any shares.

------------
In my opinion you should ditch the black and Scholes formula, Beta doesn't give you any real guide to actual longterm risk, crunch the data of the actual companies from a business perspective, and you find gems like FMG currently is where the options prices way over valued compared to the actual business risk involved, which allows a long term play with patient capital to profit from the markets mis pricing.


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## wayneL (13 November 2020)

The point may be missed that the allegory of the Hawk and The serpent and the dragon portfolio he's meant to be a lifetime portfolio.

Talking about the expense or not of insurance at any one particular point in time it's not relevant in the timeframe being considered. As mentioned several times now by both myself and The Ductser, in the context of this thread it is off topic.

But in the context a discussion as it has progressed, let look at ratio spreads, which is one of the ways in which is proposed for being strategically long volatility.

Reverse ratio put spread as proposed, is put on at all near zero cost (notwithstanding SPAN requirements for the long put risk at expiry). This is at the cost near term -Delta. However in our corner fighting for us if and when the market blows the f*** up, is positive gamma.

We can dodge the substantive portion of -theta in the valley of the shadow of death I using long dated options which maximizes our vega anyway.... That's what we want.

We can roll the spread as appropriate well before expiry so the decay is ameliorated, if the market is hovering around that strike.

Now let's turn the whole thing around and do the mirror image, ie -gamma ratio spread.

Ya still wanna play?

Not this little black duck, that is for sure. The apostle Taleb would be pulling what remains of his hair out at the mere thought of it and brother Cole it would be walking away, shaking his head, and muttering to himself.

If you want to play the short options game, that is completely fine but it is a whole different thesis and a whole different approach on a whole different time frame.

I'm not averse to throwing my hat in that particular ring at times, but as an ad nauseam reiteration, that is not the topic thread.

If I'm sure options I want to be on top of the market all the freaking time, so if the barbarians are at the gate I can bid a hasty retreat with the minimum of damage.

In a dragon portfolio of which long volatility is a portion thereof, the idea is to be able to do a little fishing in the morning, make siesta with the missus and play a guitar while drinking beer with my mates in the afternoon... With just a little tweaking up the portfolio here and there every few weeks.... or months. (Bonus points for the allegorical reference).


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## Sharkman (13 November 2020)

wayneL said:


> Now let's turn the whole thing around and do the mirror image, ie -gamma ratio spread.
> 
> Ya still wanna play?




you're referring to a ratio put front spread i take it, eg. buy 1 ATM put, sell 2 OTM puts, same expiry? sure, i do 'em fairly regularly. got one on BHP (36.50-35 for 0.18 credit, expiring next week) right now. different strats appeal to different people/objectives. but ok, happy to set aside the short gamma stuff for another time/topic and focus on the put back spreads. though i can't offer much in the way of discussion on that (and whatever i say is liable to be wrong) as i'm very inexperienced in this area - i've done maybe 2 or 3 of those lifetime. but definitely interested in delving into some details, maybe with some hypothetical trades (with realistic market data) if anyone's keen.

so from my limited understanding of the put back spread, it does cover tail risk better, but as far as i can tell, the market already knows this/factors it in, and 99.9% of the time it will charge a hefty IV when buying say 25d puts, vs ATM where you're selling a leg at least a few vol lower, making it harder to put this on for small credit or at least zero cost (which i imagine is what we're striving for here).

if you go further out in time, then you have to widen the distance between the strikes to keep it relatively close to zero cost, thus increasing the width of that dead zone where you take losses on a moderate fall. if the lower strike is too close to ATM, negative theta would be almost unavoidable? maybe turning it into a diagonal where the quicker decay of the front month sold ATM better counteracts the negative theta of the larger number of bought back month OTMs could be an alternative, but that has its own risks.

from memory, the few times i traded this, i ran into the same sort of difficulty as cutz mentioned, it drops to that dead zone around the lower strike and gets stuck there. you're paying a truckload of decay at that point. how would one go about managing the position then - what sort of factors eg. time to expiry would be taken into consideration when looking to roll, letting it play out a bit more etc.

choice of strikes would be an important consideration too i'd imagine, and possibly that's where i went wrong in my earlier attempts at this strategy. a few alternatives just thinking off the top of my head here:

- sell ATM, then buy twice as many OTMs at the highest strike that will get the whole structure to zero cost?
- line up the lower strike with some perceived support level? then sell half as many of the upper strike at whatever strike gets it close to zero cost? or sell the upper strike at ATM and adjust the ratio instead to get it to zero cost?
- line up the lower breakeven with that support level?

probably many other possibilities there. what would everyone else take into consideration when selecting the strikes/ratio used for such a strategy?


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## cutz (14 November 2020)

Sharkman said:


> - sell ATM, then buy twice as many OTMs at the highest strike that will get the whole structure to zero cost?
> - line up the lower strike with some perceived support level? then sell half as many of the upper strike at whatever strike gets it close to zero cost? or sell the upper strike at ATM and adjust the ratio instead to get it to zero cost?
> - line up the lower breakeven with that support level?




Pre Covid it was possible to do a 1:2 for a credit (XJOs 300 wide ) depending on strike selection, haven't done these in a while having a preference for iron flys with adjustments, the recent meltdown left me shaken, this week after closing out front short puts best compromise for me at approx 60 DTE, a 2:3 ratio,  high sixties credit with some meltdown protection.

The call side is still a work in progress.


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## ducati916 (14 November 2020)

1. that's all true, but that's only evaluating a single month in isolation, the strategy has to be evaluated over the longer timeframe. it's a bit of a stretch to selectively pick and choose which months you'll buy protection and which months you won't, because you don't reliably know in advance which month the 10% blowup will occur in, nobody does. you don't insure your house just for January and leave it uninsured the rest of the year. and if you adopt the approach of waiting for signs of a potential blowup before taking out the protection, the IVs will have already risen by then making the premiums drastically more expensive.

2. if the blowup happens a year into the strategy, assuming constant vols the put seller will have already collected *$93* in premiums, minus whatever is lost in the months where the options only expire slightly ITM. there's a decent chance that's going to be more than $35.49.

3. even if the blowup happens in the first month, the put seller is temporarily down $26.19, but if sufficiently collateralised so that one month doesn't knock them out, they can make it back over the coming months, as the market just does not fall by 10% a month for several months in quick succession, in the same way that you don't have disasters requiring you to claim on your home insurance month after month (if you do, i'd suggest maybe moving somewhere else?)



Mr Sharkman:

1. That $4.92 is 1 years worth of premiums (if we are talking about FMG). All it takes is 1 decline of that magnitude, 28% and the entire year's premiums vanish. Through the year (see chart) there were any number of falls of a magnitude that are going to cause losses. I count 3 significant falls and another 2/3 lesser falls. As Taleb said: Where all swan's are considered white, you only need 1 sighting of a black swan to disprove the assertion (hypothesis) that all swans are white.

2. Right so now you are referring to SPY. (a) you can't assume constant vols. as vols. constantly vary, (b) there have been more than 1 instance this year of falls that would cause losses significant enough to invalidate the strategy: 1 major, x2 over 10% and a number of lesser declines. On the SPY this is a losing strategy the way VC advocates. 

3. If it happened in the first 3 months (which it did) and you were selling 1/month, you will be down huge, as there was a 40% decline. You would never have seen the rest of the year, as you would have been carried out on your shield.


Mr VC said:

1. There is only 2 months until the Jan contracts expire, not 3.

2. and as Sharkman pointed out, you selectively assuming this sudden drop happens within the first 2 month period, which's I said if it happened would result in a good speculative gain, but as longterm strategy, paying 30% per year of an assets capital value is probably no going to be wise, because you are counting on a shorter sudden drop, if that doesn't happen you will be bleeding capital.

3. I will happily sell you insurance on FMG stock at $16.50 for 40 cents per share each month for the rest of your life if you think its a great deal, I would suddenly have a great little synthetic FMG portfolio paying $4.80 in dividends per year, that a synthetic 29% dividend yield for me, and I didn't even have to buy any shares.

------------
4. (a) In my opinion you should ditch the black and Scholes formula, 

(b) Beta doesn't give you any real guide to actual longterm risk, 

(c) crunch the data of the actual companies from a business perspective, and you find gems like FMG currently is where the options prices way over valued compared to the actual business risk involved, which allows a long term play with patient capital to profit from the markets mis pricing.



1. Immaterial.

2. It makes no difference 'when' it happens if it happens. Secondly, there was more than just the 1 fall in reality. Your strategy entails risk that you are seemingly unaware of.

3. I'm sure you would.

4. (a) Do you have any actual data or an argued position (reason) that Black Scholes should be ditched other than your opinion? I'm perfectly aware of some of its shortcomings, are you? If so, clarify your criticism and provide some value, rather than simply the empty 'in my opinion' which tells me nothing.

(b) The only way you live to see the 'longterm' is surviving the short term. It has already been demonstrated that there is a high probability that you would not survive the short term, in the way you have argued your position.

(c) We have already been down that avenue: https://www.aussiestockforums.com/threads/the-education-of-an-investor.34402/page-16, you missed blatant financial statement fraud.

jog on
duc


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## Value Collector (14 November 2020)

ducati916 said:


> . (a) Do you have any actual data or an argued position (reason) that Black Scholes should be ditched other than your opinion? I'm perfectly aware of some of its shortcomings, are you? If so, clarify your criticism and provide some value, rather than simply the empty 'in my opinion' which tells me nothing.
> 
> (b) The only way you live to see the 'longterm' is surviving the short term. It has already been demonstrated that there is a high probability that you would not survive the short term, in the way you have argued your position.




I am not sure what your concept of “long term” is, but I have 8 years of profitable options trading under my belt now, with zero years of loss, and this year is by far the most profitable.

And I have never once used the black and scholes formula, to be honest I couldn’t even tell you what the Greeks “gamma” and “delta” are, they are actually entirely irrelevant to my strategy.

My strategy is based on Manuel underwriting based on company fundamentals / business valuations, and writing conservative levels of insurance against a small number of companies that I understand from a business perspective through the cycle.

if understand a company, and are operating from a business / underwriting perspective, the black and scholes formula is not required.

In my opinion the black and scholes formula is a short cut technique for those that want to avoid doing the leg work of Manuel valuation and underwriting, it substitutes the “real risk” with “volatility”,when in reality risk and volatility are not the same thing.

infact I think I have profitably taken advantage of the system by identifying situations where volatility is high, but actual long term risk is low which as in the FMG example allows me to sell insurance for much higher prices than is warranted.



> immaterial




collecting 6 premiums a year vs 4 is not immaterial.


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## Value Collector (14 November 2020)

Also Duc,

If you reply can you use the actual reply button, they way you are doing it means I don’t get a notification, and the layout of your replies is also very confusing.


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## wayneL (14 November 2020)

I think we're getting a little bit off on a tangent with regards to time horizons here. Cole model his portfolio thesis based on the last 100 years of data to try and find a superior way to have the very long-term portfolio strategy rather than the standard 60/40 stocks and bonds.

This is no trading strategy and in no way resembles constantly selling premium. As I said several times already that is a whole different ball game in its own right, hence to points The Ducster is making above.

@Value Collector have you actually read the Allegory of The Hawk and The Serpent?

The outline is here as well as a link to the PDF of his original paper. This will explain the particular philosophical approach to that portion of his proposed portfolio that is volatility as strategic investment so we don't get further waylaid off on this strategy is better or that strategy is better. The idea is to discuss ways of doing this.






						Welcome — Artemis
					






					www.artemiscm.com
				




Th intention here was to discuss the ways that one could construct long volatility in portfolio. There are various ways, long puts is one way reverse ratio spreads are another way.

On can even discuss the use of VIX futs)ETFs and other options strategies (or not as the case may be), that what I was trying to discuss here.


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## Value Collector (14 November 2020)

wayneL said:


> I think we're getting a little bit off on a tangent with regards to time horizons here. Cole model his portfolio thesis based on the last 100 years of data to try and find a superior way to have the very long-term portfolio strategy rather than the standard 60/40 stocks and bonds.




Over the latest 100 years, you would have been better just owning 100% stocks, no bonds and no hedging, provided you have the stomach muscles to accept the ups and downs.

Maybe you guys know of free ways to hedge against volatility, I don't know of cost free hedging, as far as I can see hedging always costs something, and it general it would be better over time to take that risk on your own balance sheet.


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## wayneL (14 November 2020)

Another one on ignore.... FFS!


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## ducati916 (14 November 2020)

1. I am not sure what your concept of “long term” is, but I have 8 years of profitable options trading under my belt now, with zero years of loss, and this year is by far the most profitable.

2. And I have never once used the black and scholes formula, to be honest I couldn’t even tell you what the Greeks “gamma” and “delta” are, they are actually entirely irrelevant to my strategy.

3. My strategy is based on Manuel underwriting based on company fundamentals / business valuations, and writing conservative levels of insurance against a small number of companies that I understand from a business perspective through the cycle.

4. if understand a company, and are operating from a business / underwriting perspective, the black and scholes formula is not required.

5. In my opinion the black and scholes formula is a short cut technique for those that want to avoid doing the leg work of Manuel valuation and underwriting, 

5.(a) it substitutes the “real risk” with “volatility”,when in reality risk and volatility are not the same thing.

6. infact I think I have profitably taken advantage of the system by identifying situations where volatility is high, but actual long term risk is low which as in the FMG example allows me to sell insurance for much higher prices than is warranted.



7. collecting 6 premiums a year vs 4 is not immaterial.



1. I could write a long list of those that have blown themselves up, but the one closest to your heart would probably be Ben Graham. 8yrs is nothing, a blink of an eye. Your argument is that the past is a fair predictor of the future. In some walks of life, that may be a fair assumption. In the markets, it is not.

2. So your assessment of the tool is based upon zero application of it. Does that not rather suggest that your mind is closed?

3. Which as far as it goes, is fine. However you have inserted into that strategy, the use (abuse) of derivatives. We have (12 yrs ago, outside of your current range of experience) had the financial system almost topple due to derivatives and the so called Masters of the Universe blowing themselves up. Buffett himself suffered significant losses on a purchase, due to derivative exposure that he failed to correctly calculate his exposure on (the fundamentals are affected by derivatives). Since you now drive a TSLA, I'm guessing you may have forgotten, playing with petrol next to a bonfire is dangerous.

4. But as you have never used the B/S model, don't understand its inputs and outputs, that is simply an uneducated position to take. Second, what you are trading is a derivative, which while linked to your 'business', will not (necessarily) due to the leverage, reflect even approximately any fundamental value you have calculated.

5. All I see is the evidence, provided by yourself that you are too lazy to investigate whether the B/S has any value to add to your positions. Your opinion as to whether others are lazy/etc, is simply an unsubstantiated opinion, a bias, a prejudice.

5(a) You don't even seem to understand your own arguments: if your argument is that volatility and risk of common stocks are uncorrelated, that is a position argued by long term buy and hold investors, essentially I agree. However if you are a day trader trading common stocks, that statement is false: volatility and risk are highly correlated in common stocks.

However, that is not even the issue: your position is that volatility and risk are not correlated in OPTIONS. That is simply incorrect. Of all the variables that create the price of an Option (Time, Price, Volatility, Interest Rates, Strike Price Dividend yield) volatility has possibly the most significant impact of all.

6. If you 'think', then you are only guessing. If you knew, you could provide all the data of the trade and demonstrate exactly why it is a good trade or even a great trade. Even with all of that, it can still go wrong, but, you will know exactly why/when it has gone south and the correct response to that change. You have no idea.

7. If your total collection of premium is $4.96 (whatever) then explain to me why it is material that you collect it over 6 periods rather than 4 or any number that you choose.

This is really for whoever is interested. It is a thread from a British forum on exactly this topic, selling Options premium, by a chap who thought he was just a little special: https://www.trade2win.com/threads/plain-vanilla-options-trades.23221/

@wayneL, you will enjoy this one!

jog on
duc


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## Value Collector (14 November 2020)

ducati916 said:


> 1. I could write a long list of those that have blown themselves up, but the one closest to your heart would probably be Ben Graham. 8yrs is nothing, a blink of an eye. Your argument is that the past is a fair predictor of the future. In some walks of life, that may be a fair assumption. In the markets, it is not.
> 
> 2. So your assessment of the tool is based upon zero application of it. Does that not rather suggest that your mind is closed?
> 
> ...




I am still not sure why you are not clicking the reply button, and structuring your replies in this way but.

1, I have been investing for 24 years, I added options as an extension of my strategy 8 years ago, I made a lot of money in the GFC, so yes that bit of history I have Experianced.

2, my mind isn’t closed about the Black Scholes formula, I studied it quite a bit when I was first learning about options, I have just decided that it isn’t necessary, and that a manual valuation is more accurate, as I said Beta doesn’t tell you about risk, it’s a short cut at best.

3, how am I abusing derivatives?

4, if I calculate that XYZ company is worth $4 per share, and would be happy to add it to my portfolio at that price, and some one wants to pay me $0.10 every 3 months for an option to sell me their stock at $3.50, I don’t need the B/S formula to tell me that that’s a great deal, I can earn an 11% return on my notional XYZ shares until they drop and I have to take delivery, that not “abuse of derivatives” that’s sound underwriting.

5, I am not a day trader, I am a long term investor in the process of accumulating an ever larger amount of stock, selling puts is just part of that strategy, think of it like have a buy order open that I get paid for have open, where I base the prices I accept are based on my manual valuations rather than B/S formula.

6. don’t get hung up on the word “think”, it’s just a figure of speech, I am far more likely to use words like “I believe” or “I think” than “I know” especially when something is kind of unknowable or based on estimates such as valuing a company or assessing risk, it’s easy to know the beta of a stock, it’s harder to know the actual real world risk, that’s why they chose to use the beta in the B/S formula because it’s easy, but knowing the precise beta doesn’t give you an edge over someone who has an understanding of approximate real world risk, who was it that said it’s best to be approximately right rather than precisely wrong? 

7. because we were talking about earning $X amount per contract,  6 contracts is more than 4 contracts, eg if I said I was going to pay you $10,000 every 2 months, you would earn more than if I paid you $10,000 every 3 months.


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## ducati916 (15 November 2020)

Value Collector said:


> I am still not sure why you are not clicking the reply button, and structuring your replies in this way but.
> 
> 1, I have been investing for 24 years, I added options as an extension of my strategy 8 years ago, I made a lot of money in the GFC, so yes that bit of history I have Experianced.
> 
> ...





1. Ok, on that basis then you will accept that certain businesses (common stocks) were bankrupted and liquidated during that period, 2 of the more famous examples being Bear Stearns and Lehman's. A risk when investing in financial markets is that the business fails.

2. Now you say you have studied it extensively, in your prior post you said:






The lack of a consistent position is concerning.


[4] and [5] because this is the issue: 

(a) You are valuing a common stock at (in your example) $4/share. You are selling a PUT at Strike $3.50 and will take delivery in a price decline. In your eyes you are buying at a $0.50/share discount, ignoring the price decline (beta) as short term and irrelevant.

(b) This allows you to ignore the losses on the Option, because you will take delivery. There are no margin calls as you will have the cash to take delivery of the shares.

(c) The 'risk' is that your valuation is wrong and/or that business is liquidated. Your loss on that entire transaction is now 100%.

This strategy is not 'selling insurance', when you sell insurance, you indemnify the buyer against loss. Insurance is sold to someone. You are selling a PUT that you intend to use yourself. That is not selling insurance. Your incorrect use of terms has created the confusion on this thread. 

This is definitely not what @wayneL is referring to. This is a strategy that value chaps play to try and boost returns because they have uninvested capital. As such it's not right or wrong, but it is totally irrelevant to this thread.

6. The word 'think' is the correct word to use because, you don't know. Which is exactly why I posted:






7. This is basic error.











No we are talking about earning $4.96 in sold premium *in TOTAL.* Therefore if the maximum you can earn is $4.96 you would actually be better off earning it all at once and being able to sell for the total premium in 1 transaction.

As for [3] that is rather self-explanatory.

jog on
duc


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## Value Collector (15 November 2020)

ducati916 said:


> 1. Ok, on that basis then you will accept that certain businesses (common stocks) were bankrupted and liquidated during that period, 2 of the more famous examples being Bear Stearns and Lehman's. A risk when investing in financial markets is that the business fails.
> 
> 2. Now you say you have studied it extensively, in your prior post you said:
> 
> ...




1. yes, companies went bankrupt and the Beta of their stock didn’t give any idea of the risk for the years and months leading up to that, however if you have seen the movie the Big short, you will see guys that did Manuel valuations of the underlying bonds etc figured out what was happening and profited from it.

2. Yes 8 years ago when I first started researching options I read quite a bit about about the BS formula, but yes now I couldn’t tell the what delta or gamma are, I have data dumped that because I don’t use it.

B, what losses on the options I take delivery of? I hardly think taking delivery of FMG at $5 has caused any losses, but when I do take delivery of stock, the difference between the market price and the price I paid is recorded as a loss against my options income, and the market price is recorded as my cost price for those shares I hold long term, so no I am not ignoring any losses, I know my profit and loss to the cent.

c. Obviously, but that is the same for anyone that buys stock, either out right or using put options, what’s your point?

I am not sure you understand put contracts, they are a perfect example of selling insurance, you paragraph about them not being insurance doesn’t make sense at all, when I sell you a put contract, it is indemnifying you against the drop in price of the asset named in the put option contract, I am guaranteeing you I will buy it for a certain price with in a certain time.

6. yes it is the correct word to use, that’s why I used it,  because as I said we are dealing In Things that are unknowable and can only be estimated,  just because you say you “know” doesn’t mean you do, saying “I think”shows humility not ignorance in fact claiming to know the unknowable is arrogance and ignorance.

7. No, if you go back to the start I was describing earning $X on a certain contract and then multiplying that by 6 to get the annual rate, but then in your example you used that $x figure for 3 months which if you extrapolated that would have given you a wrong annual figure, hence why I said it’s a 2 month contract, but we are last that example now so who cares.


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## ducati916 (15 November 2020)

Value Collector said:


> 1. yes, companies went bankrupt and the Beta of their stock didn’t give any idea of the risk for the years and months leading up to that, however if you have seen the movie the Big short, you will see guys that did Manuel valuations of the underlying bonds etc figured out what was happening and profited from it.
> 
> 2. Yes 8 years ago when I first started researching options I read quite a bit about about the BS formula, but yes now I couldn’t tell the what delta or gamma are, I have data dumped that because I don’t use it.
> 
> ...





Thanks for the discussion, it has been illuminating.

jog on
duc


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## wayneL (15 November 2020)

ducati916 said:


> @wayneL, you will enjoy this one!
> 
> jog on
> duc




I remember following that thread at the time, most amusing.

When I have a spare hour I'm going to read back through it, thanks


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## cutz (16 November 2020)

wayneL said:


> @Value Collector So long as the gamma monster doesn't catch you.
> 
> To repeat once again, the same beast that ate LCTM.
> 
> ...




Hi @wayneL , you referring to Long Term Capital Management ? When Genius Failed is one one my favorites reads, I often refer back to it.

FWIW, during my learning phase,  ( although must admit I'm always in learning phase ) ,  I too was a naked equity put seller, quickly came to the realization that when short OTM puts get hit, it's because the underlying fundamentals/trend has shifted, reasons for wanting to be long quickly evaporate.

Anyhow nice thread, thanks for bringing the issue up, haven't got much to contribute but it has led to me to question myself whether I should personally be more aggressive long vol, sacrificing some premium in order to not having to stress out so much...


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## wayneL (16 November 2020)

cutz said:


> Hi @wayneL , you referring to Long Term Capital Management ? When Genius Failed is one one my favorites reads, I often refer back to it.
> 
> FWIW, during my learning phase,  ( although must admit I'm always in learning phase ) ,  I too was a naked equity put seller, quickly came to the realization that when short OTM puts get hit, it's because the underlying fundamentals/trend has shifted, reasons for wanting to be long quickly evaporate.
> 
> Anyhow nice thread, thanks for bringing the issue up, haven't got much to contribute but it has led to me to question myself whether I should personally be more aggressive long vol, sacrificing some premium in order to not having to stress out so much...



Ugh, yes LTCM not LCTM

Anyway, it's like any long investment, try to buy low (Vol) and sell high.

The good thing about volatility is that it is is readily and easily quantifiable via IV/SV, VIX, and other such tools.

The bad part is that patience is required, which attracts me to the Dragon portfolio idea.


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## Value Collector (16 November 2020)

cutz said:


> Hi @wayneL , you referring to Long Term Capital Management ? When Genius Failed is one one my favorites reads, I often refer back to it.
> 
> FWIW,




I own a copy of that book also.

As an interesting side note to my conversations in this thread, it’s interesting that Duc seemed to think that me not using the Black scholes formula put my portfolio at risk, but the biggest blow up in history “LTCM” was presided over by the creator of the formula.

I believe LTCM failed for two reasons they trusted these short cut formulas to make broad bets without doing individual Manuel evaluations, and they used huge leverage which meant they couldn’t absorb the volatility.

I am not bothered by volatility, I am extremely long term focused, and I keep leverage within limits, so I feel I am set up in a way that by selling naked puts, I can profit by accepting by people who don’t want volatility paying me to put it onto my balance sheet.


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## wayneL (16 November 2020)

Value Collector said:


> I own a copy of that book also.
> 
> As an interesting side note to my conversations in this thread, it’s interesting that Duc seemed to think that me not using the Black scholes formula put my portfolio at risk, but the biggest blow up in history “LTCM” was presided over by the creator of the formula.
> 
> ...



That's nice, but still very much off-topic


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## wayneL (16 November 2020)

This is a great podcast discussing long vol with Chris Cole, the author of The allegory of the Hawk and The Serpent, purveyor in chief of long vol as part of a portfolio... With Grant Williams and The Fleck.

It's a great listen whether interested in this or not.


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## cutz (20 November 2020)

wayneL said:


> This is a great podcast discussing long vol with Chris Cole, the author of The allegory of the Hawk and The Serpent, purveyor in chief of long vol as part of a portfolio... With Grant Williams and The Fleck.
> 
> It's a great listen whether interested in this or not.





Nice podcast, sort of confirmed what we already were aware of ( here on ASF ) , the derivatives markets is so large that it influences the underlying market, once it was the other way around, I've been referring to it as back driving,  try explaining it to ppl that don't do derivatives, they look at me like I'm nuts !!


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## InsvestoBoy (29 November 2020)

Perhaps I can chime in @wayneL ...since it doesn't really seem like anyone actually bothered to engage with the topic at hand on its merits but rather just talk their book or their d***.

The strategy is not called "The Hawk and the Serpent" it is called the Dragon Portfolio. Allegory being that the dragon tames both hawk and serpent.

I follow Chris Cole closely and his writings, especially the Dragon Portfolio concept since it is an interesting twist on the Permanent Portfolio construct which I use for my own SAA.

The main thing to understand is that this is a global macro portfolio. So you have to give up some expectation of niche specialisation (like investing in individual ASX issues) and go for asset classes under the assumption that each asset class is somewhat efficiently priced *within itself*. You might be able to move within the asset classes to some degree, and I do as have previously discussed several times on ASF, but by and large you are running a global macro portfolio and returns are dependent on macro regime shifts, not any niche specialisation.

The purpose of this global macro portfolio is akin to the Permanent Portfolio, to "harvest volatility" (https://thepfengineer.com/2016/04/25/rebalancing-with-shannons-demon/) of uncorrelated asset classes that each do well in different macro regimes. Key here being uncorrelated, not negatively correlated. The "twist" being to add two trading strategies and treat the return stream of those strategies as an asset class and subtract cash as an asset class.

Both the trading strategies are actually what you would consider, from a quantitative return profile, as long vol strategies.
* Commodity trend following: using commodity futures only to capture inflation trend, compared to most CTA funds which "diversify" across all futures.
* Long options vol: if you follow Artemis Capital filings etc you will see that their long vol strategy is not something you can replicate easily because it isn't systematic. They are professional options traders looking for options idiosyncracies across asset classes. As just one example, I recall they were long some GC calls in early 2020. It isn't just what most people think of buying puts or other long vol strategies for equities only. They are very tactical and sophisticated on the trades.

The purpose of both of these strategies is to capture macro risks *which are not present in the market today and have not been for some decades*, but which are believed may eventually return and are completely mispriced today.
* Inflation
* Regime shift from mean reversion (negative autocorrelation in daily returns) to momentum (positive autocorrelation in daily returns) across macro asset classes.
* Changes in interest curves (inflation) which influence options Rho, *in the past long options strategies actually carried positive and they may one day again!*
* Capture eruptions in vol pricing, this is not always price negative. In commodity space, vol increases are quantitatively associated with price increase quite often. Long vol is not necessarily bearish.
* Take the other side of structural short vol bets from equity buybacks/VaR/risk parity/explicit short vol structured products which currently rule the roost.

If you don't think that simple commodity trend following can be long vol just look at the return profile of http://www.40in20out.com/ as a trendfollowing benchmark.

The point is to get into these "strategies as asset classes" today, even though they have not done well over the last few decades. The goal is not to get into them for profit per se, the goal is to capture their uncorrelated rebalancing volatility (see above link) against macro risks that are not currently present but may return one day.

In the same way as when you enter into a Permanent Portfolio, you have an expectation that some components of that portfolio will do badly while others do well,* this is an explicit part of the portfolio construction*. You expect drawdowns in whichever asset classes are not expected to perform favorably in whatever the current macro regime is, and actively rebalance into them using profits from the asset classes that are performing favorably in the current macro regime.

Almost nobody in the world (aside from a few PP adherents and even smaller cohort of Dragon Portfolio) are running Constant Mix (https://cssanalytics.wordpress.com/...et-allocation-lessons-from-perold-and-sharpe/) portfolios that have concave payoff profiles today, which adequately hedge against all macro risks that Chris Cole has spoken about and I summarised above. A *lottttttt* of people are running Constant Mix in the form of 60/40 portfolios but both the assets in that SAA will not do well if Risk Parity shits itself again or inflation picks up. That is Chris' whole point. If you are running 60/40 or Risk Parity, you need to change it up to hedge the future. If you are a niche specialist who thinks nothing macro matters, then none of this is relevant for you at all.

And that concave action is so important to understand in all of this. It's the rebalancing that makes it powerful. Not the exposure to long vol, not the commodity trend, etc. That concave return profile is in a sense long of vol itself, in that it is always on the other side of the trade of structural short vol trades like those mentioned above.

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Personally I haven't switched from PP to DP. The lessons from Hawk/Serpent are different for US investors than AU investors! If you are a US investor running PP on US long bonds, gold, USD and US equities then you are very heavy on deflation trades. AUD holdings and AU equity indices are a different beast (due to sectoral differences) and should be expected to do a lot better in inflation/autocorrelation regimes like we saw 2003-2007 where AUD and Aussie equities just smashed it out of the park. Similar shape up from the March 2020 lows.

So I have kept to the PP but I try and tweak the holdings within the cash and equity asset classes to get some natural exposure to commodity trend (higher weight to AU equities and EM equities) and dynamic changes to USD and AUD allocation within cash because AUD absolutely crushes it on reflation shifts. I also take some discretionary and tactical long options positions and if vols are cheap (not really the case since Feb 2020 when being long vol reaaallly paid) I will put on some equity tails based on https://thefelderreport.com/2016/08...-heres-how-you-can-tail-hedge-your-portfolio/ this strategy.


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Hopefully that is more engaging on the topic you wanted to discuss.


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