Yes, maybe the professionals have a deeper understanding of the math behind options pricing, but we don't believe that prevents retail traders from winning. And these days, the technology available to individuals is absolutely good enough for anyone to win with. Choices like LiveVol and ThinkorSwim are cheap enough (or free) for anyone to afford, so that is not a valid reason for losing, either.
The truth is much simpler than that. The real reason most people lose is because they're almost always buying options. That's it. That's the whole answer. And it's not even their fault. Brokerages won't allow most people to sell options and will almost always tell you that selling options carries a huge amount of risk and should be avoided. They scare people away from it. While it's true that selling options is riskier than buying them, we believe that anyone can easily be taught that risk, and that selling spreads can alleviate almost all of that extra risk.
Not believing us yet? Ok, here's a little bit of research to back up our claim. We took 11 different high-volume stocks and back-tested 2 years worth of data. For each day, we looked at the IV30 (taken from LiveVol) and then looked ahead 30 days at the HV30 (also from LiveVol) to see how they compared to each other. The results will amaze you.
1. AAPL - total of 471 days checked.
IV30 was higher than HV30 - 62.00%
HV30 was higher than IV30 - 38.00%
This means that if you picked any day in the last 471 trading days, there's a 62% chance that the 30 day implied vol on that day predicted bigger moves than actually happened. And keep in mind this time period included AAPL dropping from 700 down to 500!!
2. GOOG - 471 days checked.
IV30 was higher than HV30 - 82.38%
HV30 was higher than IV30 - 17.62%
3. PCLN - 471 days.
IV30 was higher than HV30 - 73.891%
HV30 was higher than IV30 - 26.11%
4. SPY - 471 days
IV30 was higher than HV30 - 78.77%
HV30 was higher than IV30 - 21.23%
5. GLD - 471 days
IV30 was higher than HV30 - 62.21%
HV30 was higher than IV30 - 37.79%
6. FB - 326 days
IV30 was higher than HV30 - 44.65%
HV30 was higher than IV30 - 55.35%
This was the only stock in the study that had HV30 at a higher percentage, almost definitely because of the disaster of an IPO that they had, followed by a huge drop in the stock, and has recently had a huge rally. And with all that it still didn't win by much.
7. TSLA - 471 days
IV30 was higher than HV30 - 58.39%
HV30 was higher than IV30 - 41.61%
Amazing. This stock has had a furious rally, and still IV30 was consistently too high.
8. EEM - 471 days
IV30 was higher than HV30 - 79.41%
HV30 was higher than IV30 - 20.59%
9. QQQ - 471 days
IV30 was higher than HV30 - 77.49%
HV30 was higher than IV30 - 22.51%
10. IWM - 471 days
IV30 was higher than HV30 - 88.75%
HV30 was higher than IV30 - 11.25%
Yeah, good luck buying options in this thing.
11. GS - 471 days
IV30 was higher than HV30 - 71.34%
HV30 was higher than IV30 - 28.66%
There's not really much else to say here. The results are very clear.
Does this mean that you should just start selling options in everything? Of course not. Keep in mind that in the end the only thing that matters is whether you win or lose money, and our study here did NOT measure whether those times that HV30 outperformed IV30 would have caused option sellers to lose more than their gains. A more extensive study involving looking at the PNL of actually trading options each day would be needed to determine that, but considering how far most of these are away from being 50/50 we think its pretty safe to assume that selling options is the more profitable strategy.
Does this mean we never buy options? Once again, of course not. We buy options all the time. But we only do it when we believe they're under-priced, and we have our own pricing models that we use for that.
Even after looking at this, we still don't want to tell you to just go out and sell a bunch of options, especially in smaller accounts. But selling out-of-the-money verticals or selling Iron Condors is certainly a good strategy. The risk is limited to the width of the strikes, and it won't eat up most of your capital. The real trick is determining when is the right time to do it.
Our newest idea is to put about $50,000 in a separate account (we figure that's a good estimate of the average account size), and trade it the way we would most like a retail investor to trade it. We'll tweet every trade we make, both opening and closing, and keep a spreadsheet on the PNL. You can play along if you want, or just observe for a while to see if what we're doing is working. Given the limited amount of risk this account will be allowed to put on (we won't have portfolio margin), this will be quite different from our current strategies. We're incredibly excited to see how this goes.
