Trading is betting. Not like the casino, where your chances are less than 50%, but a trade is still a bet. Of course we would like to maximaze our chances, that`s why we develop some systems, evaluate how does the IV compares to the realized vol, etc. So it really doesnt matter much how do we trade, as long as we have an observable edge, the bigger the better.
But even the greatest edge can be ruined by inproper money-management and incorrect bet size selection. There`s a tonn on studies on the matter, but im sure we can agree that conrtoling risk is crucial. Is the risk can be defined in dollars, we can select the proper bet size, that will maximize our profits in the long term.
This is a big deal. With an undefined risk (short naked, short straddles etc etc) we simply cannot make the GOOD decision on the trade size.
Consider the Fixed Fractional Position Sizing (of which i learned from Ralph Vince`s book):
The equation for the number of contracts in fixed fractional position sizing is as follows:
N = f * Equity/| Trade Risk |where N is the number of contracts, f is the fixed fraction (a number between 0 and 1), Equity is the current value of account equity (i.e., the value of account equity just prior to the trade for which you're calculating N ), and Trade Risk is the risk of the trade for which the number of contracts is being computed. The vertical bars ( | ) mean that we take the absolute value of the trade risk (risk is usually given as a negative number, so we make it positive).
Next, to our option trades. What I DONT like about the iron condor trades is the exact risk is kinda floating. I cant say for sure how much can i lose per 1 spread - 2$ or 4$. I know just the approximate range (which still can be wrong if there a black swan event and im ITM). I also cant say in advace whether i`ll adjust or not, what the adjustments will be etc. Sure the losses are always limited, but to achive good results one needs to sell alot of lots, which makes the total max risk quite unacceptable. This all leaves me in some kind of uncertainty, which complicates betting size selection.
On the other hand, as i see it, trading equity calendars provides two important things: 1) It can provide a strong edge. 2) The exact risk is known. I cant lose more that the debit paid, no matter what happends.
The main question i have now is: do the index ICs provide a greater edge to account for uncertainty? Or, vice versa, the calendars (and other such types) do have a greater edge (more instruments to choose from; some with a heavily wide vol. spread), combined with the ability to define risk? Currently im thinking that the latter is true. We`ll see how it goes, but again, im seriuosly thinking about reducing or even dropping IC trades at all - not cause they are bad, but there may be better (risking less to earn more + faster).
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