Option Gambling

The Option Gambling Game:

Gambling Vs. Trading/Investments:

What are the differences? You can name many. Here are my perspectives. 1. Gambling has shorter life-span/duration. It is rare to see the gambling host ask you to go home and wait 1 week then reveal the result. The sudden gains/losses actually make people excited about gambling. 2. You can tell me that there are probability theories behind the gambling games. However, to most players, they don't have time to think about theories or don't even know the theories. (I hate bringing theories into talks. I just believe what I see and can do.) The relative unpredictability excites the players as well.

Let's have a gambling game in the pepsi (PEP) call option market.

If we can freely trade options anytime, we decide to start the option trading 4 days before the expiration (the third friday of each month) every month. (i.e. We are lazy, we only trade 4 days per month. 48 work days per year.) We also have one indicator - the past 5 day momentum, which is an optional reference to us.

The Strategies:

1. No momentum indicator: We ignore the momentum signal (I don't like judging alphas/signals.). Every month we just write a slight ITM call option 4 days before expiration.

2. Mild momentum indicator: If the short-term momentum is positive, we short a slight ITM call option. Otherwise, we long a slight ITM call option.

3. Strong momentum indicator: It is similar to the mild momentum indicator case except that we short the slight ITM call option when the short-term momentum is above 0.01 (This number is very large.).

2 types of strategies have been tested. The first type is exactly the same as described above. In the second type, the short position was changed as the long position.

Results:

Figure 1. Type 1 Strategy Monthly PNLs

Figure 2. Type 2 Strategy Monthly PNLs

Summary:

Now you might understand why I call these option gambling. Just 4 days before expiration, we enter the position and short ITM call options, which turns out to be a nice pnl chart. If we long ITM call options when the short-term momentum is rather large and short ITM call options when the short-term momentum is not that large, the pnl chart is not very bad.