option trading...whats the catch????

Hello all,


So i was reading option trading and one study showed that it was possible to make 10% return per month on the CBOE by the simple following trading strategy: buy options when implied volatility is low and sell when implied volatilty is high. Implied volatility is mean reverting so if its low it will go up.


My question is: is it so easy to profit from options trading? The 10% montly return is huge!!!! Or is there a catch here???

A whole firm nearly blew out doing that in early 2001. They bought options on the lull after that winter low, and they just died.


I do know of a guy who uses econometric models to predict the recurrence of volatility pops in individual stocks, though.


The thing with options, is it is so easy to construct a skewed strategy without knowing where the long tail is.


eLROY

the traditional argument about speculating with options is that transaction costs are too high. options are an excellent tool to have for hedging. i dont know about the 10% month part but if it was that easy everyone would do it.

The paper was published in 1978 so it might have been eliminated (or reduced) since everyone started doing it (similarly to the january effect in the stock market). Up until 1990 the january effect had 10% return too.


(By the way it's referred to in Hull - options, futures and other derivatives p. 149). Also, this website refers to it:


http://www.optionvue.com/Articles/ArticleBuySellVolatility.htm


and describes a very profitable situation can be constructed. I guess it doesn't provide 10% return per month but it should be still profitable.

All academic studies of hypothetical options profits are pretty much nonsense. Though, they may hav been more accurate back in 1980, when there was still huge friction in options markets.


Generally, your profits will be in proportion to how much routing friction you have to overcome to get them - like by purchasing an exchange membership - and by labor.


You can't compare a guy making $120,000 on $100,000, sweating his ass off in the pit each day, to someone passively making $100 million on a billion in a mutual fund.


eLROY