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Profiting from Risk Aversion

Geoff Considine said:

Option valuation can be theretically complex, but it is ultimately just a matter or valuing the probability distribution in returns beyond the strike price. Even with a fat tailed distribution, you can model that upside somehow.
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Sure, you can model it somehow. The problem is, "somehow" is a "model," and that model is based on a technical evaluation of whatever you see as a value indicator for future performance. This "feeling" that you have that you may be correct, is an emotional reaction that may, or may not be indicative of the future. If you're lucky, you make money. If you are unlucky, you lose money. But if you are lucky, it doesn't prove that your analysis has been correct or that your method will go on to win again. To know you have a solid technique that really works requires mathematical proof, and the human behavior that determines market prices in the future (buying and selling) cannot be predicated mathematically.

So whittle away with your technicals. But sorry, none have yet been proven to be better than random chance in the long run.

A better way is to focus on the long term. Everybody knows we will eventually get out of this mess. Maybe it will be 2 or 3yrs, maybe 5 or 6yrs, maybe 10yrs or more. Looking down the line and becoming as aware as possible of the macro economic forces of slow waves that are moving through the economy right now, like: increasing unemployment, increasing deficits, increasing bankruptcies, decreasing consumer spending, decreasing liquidity, decreasing confidence, etc., all say its going to be awhile before these trends turn around and the economy starts growing again. So a good bet if you want to go long is buy and hold for the long term. Or, maybe the reverse in inverse index ETFs for the short to medium term, although that's more risky. Beyond this kind of generality, like trying to predict the short term with technicals, is likely to prove a dangerous waste of time.

Profiting from Risk Aversion

Although the price of options is related to volatility, the real relationship is quite complex and involves other variables. This is well understood today.

It has been shown mathematically that trading with options in the long run, when all things are appropriately considered, including transaction costs, is basically a zero sum game. (You may do great selling calls this quarter, but next quarter you may lose your shirt.)

It is also true that flipping coins in the long run is a zero sum game. That's not to say that you can't make money flipping coins. You certainly can. But you can also lose money. In the long run, if your goal is to make money consistently, then you are wasting your time flipping coins and playing options.