Option profitability calculator on paper

[Jocomail78 0]

 

Hey.

There's something that does not add up for my math. Neither on paper, nor on the trading platform.

I've read multiple posts, watched around 100 hrs of material on Youtube, constantly learning about option trading, yet I still consider myself a newbie in this field.

Already maxed out a couple papertrade accounts, all of them were providing the expected (reasonable) outcome according to the assumed risk. But that's about me.

My problem is the following:

If I calculate the profitability of an individual trade and assume that I'm going to do it 1000 times (just to align with the deltas and with the calculated probability of profit) I can't find a single trade which would be profitable.

How do I do my math, will be presented through a simple calculation on SPX:

Checking on SPX, which is currently at 5566. (08 July 2024)
46 DTE,
Selling put at 5310, for 20.00 (mid price), delta at 0.14 (86% probability of profit)
Buying put at 5300 for 19.15 (mid price) delta at 0.13 (87% probability of profit)

My calculated probability of profit on the platform I'm using is 88% (would be more at 86.5, but let's move on)

The credit received will be at 85$, max loss is 915$

So if I make my calculations, and I do this trade 1000 times, on average I will lose on each trade 35 $.

(85 (max win)*88 (probability of win) - 915 (max loss) * 12(probability of loss) / 100 = -35

Checked multiple expiration dates, multiple different cases, each time, the mid price is always lower than my calculated break even point

Break even point for me is calculated the following way:

Spread width * 100 * (100 - Probability of profit) / 100

So for a spread width of 10 and POP at 88% that would be 120 $.

This means if I'm getting exactly 120 $ for each and every trade and I do it 1000 times, I loose 12% of the time and win 88% of the time, chances are good that I'll be exactly at zero.

I've checked the same calculation both on put and call side, with iron condor, with butterflies,
On QQQ, IWM, AMZN, GOOG, TSLA, and lots of others. Still haven't found the one...

And I haven't taken in consideration the transaction cost, or to make a bracket (stop loss + take profit at 50%) or managing the positions.

Usually even the max credit I can theoretically get for this trade is lower than my break even point. And those trades surely won't be filled.

So my question is : What am I missing? How can this be even profitable (on paper at least)?

I try to be non-directional, limited risk, around 10-20 delta. 

 

[TrustyJules 3,212]

Fail to see why you are surprised, any other outcome would have shown a price distortion that would be arbitraged away immediately by the market. The rest is of course also market maker margins in the spread. Options are probabilistic so if there was a trade that showed a consistent profit it is the other side of the trade of the options that would be guaranteed to lose money. They are obviously also in it to make money.

What you show is also a typical example of the high probability low return rate and low risk of a high loss compared to the converse which is the low probability high return but low loss with high probability. At the start of any trade you are taking on a degree of risk and if everything pans out as it stands at the opening than noone should make any money. In reality however the market is the proverbial 'walk in the park' and so multiple parameters change both internally to the trade and external factors that influence the broader market. This can put your position in a profit or a loss as the case may be.

In your case - and this is the trick with most such positions and ICs etc... it is to avoid the max loss. Regarding index ICs my recollection is that if you do it monthly you get your max loss twice a year (just under) and this exactly wipes out all your small profits. Therefore avoiding a max loss even once will get you into profit - there is no mechanical way to do this but simple ideas as selling ICs or spreads when VIX is high make sense as you gain from the drop in IV if it occurs allowing you a faster way out then hold till the end.

[CJ912 136]

@TrustyJules rarely did I find markets to be like a walk in the park.....a random walk on the other hand, most definitely!

[TrustyJules 3,212]

Its a metaphor for exactly that - a walk in the park is directionless...

[falkor 254]

@Jocomail78 as @TrustyJules noted it's expected that the theoretical model yields exactly 0 profit. But all theoretical models (particularly those commonly used by trading platforms eg Black-Scholes and its derivatives) of necessity only consider limited variables. The models don't know about things like earnings, macroeconomic events, etc. Therein lies your edge. Without such an edge it would indeed be a random walk, or worse, after considering slippage and transaction costs.