The Fallacy of "Income Trading"
The Fallacy of "Income Trading"
From time to time we like to take a break from our normal in-depth analysis of the option-sphere and bust a few myths proliferated by many of my dishonest counterparts in option education. I debunked the myth that 10% a month is realistic (it's not). I debunked that trading the same trade every month works (it doesnít). I debunked that risk management is more important than trade selection (it isnít). Well itís time to go after something else, this time I am attacking a phrase: ëincome trading.í
ëIncome tradingí is one of the most popular catch phrases among option educators. I always get a kick out of retail traders when they call themselves ëincome traders.í It has come to be a term that represents traders that sell premium. These traders try to sell condors, buy butterflies, and buy calendars. The issue is, very rarely have I met an ëincome traderí that has income from options. Why?
The problem with ëincome tradersí is that they see options trading along the lines of buying bonds or purchasing an annuity. Many programs package income trading as if all it takes is a training program and the trader is on a fast train to an easy living. The term income trading almost implies some sort of certainty of receiving income from only selling options. Options, the easiest annuity than ANYONE can affordÖall you have to do is say sold!!! HA!
Whatís crazy is that EVERYONE is trying to be an income trader. Do people buy options because they intend to lose money? Do traders buy straddles, strangles and sell calendars because they are giving gifts away to the retail public. Do market makers price options in a way that anytime they are long premium they lose? The answer is no. I can promise you that I have never made a trade in my personal account with the intent of losing money (I do put on bad trades in the OP account so that I can show people what not to do).
Say what you will, but statistically, at the time of the trade there are very few times where the trader is at a true advantage (this is one reason selection is so important). A 10 delta option receives premium equivalent to an option that has about a 10% chance of getting in trouble. Why in the world would traders believe that they are going to automatically make cash?
2% 2% 2%!!!!!!!! The old saying is that implied volatility is 2% over priced most of the time. This is why traders believe they can win. It is also the number one selling point for ëincome trading.í
One interesting thing to think about is what the 2% premium represents. It would mean that the average trade has an edge that is the equivalent of 2% multiplied by the short vega of the position Greeks. However remember: a retail trader is giving away a little cash on the bid ask spread, and then the trader is giving away money to their broker in and out of the trade.
Next time one of you has an iron condor on do some math. What is 2% multiplied by the vega of the position. Is it really a lot of money? Once you subtract commissions and the bid-ask spread does that 2% of ëedgeí make the trade a big winner, a loser, or a wash? The answer is likely near a wash and possibly a loser. For example, an August SPX iron condor sold at the 10 deltas would have about 200.00 of 'edge' in it, but, minus commission in and out (80-120 dollars) and the bid ask spread (50-100 dollars) the edge is gone.
To make matters worse selling premium has become a popular approach for many other traders that are not retail traders. There are major funds that sell premium all the time. In strategies that are stunningly retail-esk many medium to large sized hedge funds are selling iron condors, puts, and calls in order to produce results.
This has caused some wild times in the market over the last few months. It is the number one reason, in my opinion, that the VIX has been able take the massive dives after major market sell offs. It has also pushed normal premium levels down to levels that relative to historical volatility (depending how it is measured) are no longer anywhere near a 2% premium many believe exists.
If the 2% edge isnít real, can a trader win? Yes of course he or she can, however, the trader has to be smart. The trader, as I have stated many times, needs to learn to trade for real edge, something we actually teach people capture at option pit mentoring and consulting. Imagine this; a trader sells an iron condor with .10 of edge to it. Add .10*100*Contracts and add that to the 2%*Vega number, now you may have a statistically significant chance of making money.
The moral of the story: learn to trade for edge. Don't be a premium buyer, don't be a premium seller, be a premium trader."
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