Misunderstanding Edge in Options Trading | Outlier Insights
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Each week I work hard to gather and curate information for your convenience. There are two main sections to the newsletter:
Market Analysis is where I share some high level key market datapoints to complement my daily livestreams.
Erik’s Musings is where I share my perspectives; sometimes market related, sometimes not.
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-Erik
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1. Market Summary
1a. Overview.
Major Indices Performance:
The S&P 500 (SPY) rose 1.01% to close at $597.58, driven by positive corporate earnings and easing inflation concerns. The Dow Jones Industrial Average (DIA) climbed 0.74% to $434.72, while the NASDAQ 100 (QQQ) outperformed with a 1.69% increase to $521.74, supported by strong performances in the technology sector.
Volatility Index:
The CBOE Volatility Index (VIX), a key measure of market risk, decreased by 5% this week, signaling a reduction in market uncertainty as investors showed increased confidence in economic stability.
Tech Sector Movements:
Technology stocks rebounded, with Intel leading gains on rumors of a possible acquisition. Speculation boosted investor interest, helping the sector recover from recent sell-offs.
Commodities Performance:
Gold (GLD) declined slightly by 0.54%, ending the week at $249.27 as safe-haven demand softened amid easing market fears. Crude oil prices also dipped by 0.47%, with WTI crude closing at $82.52 per barrel, reflecting stable supply conditions.
Cryptocurrency Trends:
Bitcoin (BTC) consolidated at $104,126, down 0.66% for the week. The cryptocurrency market saw muted activity, with traders focusing on regulatory developments and potential adoption news.
Inflation Data:
December’s Consumer Price Index (CPI) report showed a 2.9% annual increase, while core inflation (excluding food and energy) rose by 3.2%. This moderation in inflation was viewed as a sign that Federal Reserve policies may be stabilizing prices.
Bond Market:
The 10-year U.S. Treasury yield rose slightly to 4.25%, reflecting expectations of prolonged inflation and the potential for future rate hikes.
Consumer Sentiment:
The University of Michigan's Consumer Sentiment Index dropped to 73.2 from 74 in December, as Americans expressed concerns over rising costs and job security despite positive labor market reports.
Corporate Earnings:
The earnings season began on a strong note, with major U.S. banks reporting robust profits. Increased trading activity and strategic repositioning following the recent election supported their bottom lines.
1b. U.S. News
Los Angeles Wildfires:
Wildfires in the Los Angeles area continued to wreak havoc, with the death toll rising to 24 and over 12,000 structures destroyed or damaged. Emergency health advisories were issued as poor air quality posed serious health risks. Officials estimate billions in damages, marking one of the most destructive wildfire events in California history.
TikTok Ban:
The U.S. Supreme Court upheld the nationwide ban on TikTok, citing national security concerns related to its Chinese parent company, ByteDance. The company must divest the app by January 19 or face full implementation of the ban, potentially affecting millions of users.
Presidential Transition:
President-elect Donald Trump finalized his cabinet appointments ahead of his January 20 inauguration. The appointments signal a potential shift in U.S. policies, particularly in energy, defense, and trade, setting the stage for significant political and economic changes.
1c. Global News
Red Sea Crisis:
Tensions escalated in the Middle East as the Houthi rebels launched missiles and UAV attacks targeting Israeli and U.S. naval vessels in the Red Sea. In response, the U.S. conducted airstrikes on Houthi facilities, further complicating the already volatile situation in the region.
Russia-Iran Partnership:
Russian President Vladimir Putin and Iranian President Nasser Pezeshkian formalized a strategic partnership this week, strengthening economic and military ties. The agreement includes cooperation in energy, infrastructure, and defense, signaling a deepening alliance between the two nations.
Gaza Ceasefire:
After weeks of intense negotiations, a ceasefire agreement was reached between conflicting parties in Gaza, set to begin on January 19. The deal aims to de-escalate violence and bring temporary relief to the war-torn region.
1d. Sector Trends
https://www.barchart.com/stocks/market-performance
Percentage of large cap stocks above their MA
5-Day Sector Performance
6M Sector Performance
1e. Economic News
https://tradingeconomics.com/calendar
Week ahead.
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2. Erik’s Brainstorming.
I came across a post on reddit that was really interesting to me. It clearly emphasized the idea where someone knows enough to get themselves into trouble, but still has a really long way to go. To clarify, this person is on the right path - they simply have a ways to go. First, see the post below - think of what YOUR thoughts are how you would respond there.
They’re integrating important concepts like volatility surfaces, which are really useful tools for options traders along with pricing models. However, there are a series of fundamental misunderstandings here. Once you have your mental response logged, you can check out mine below:
How does this align with what you came up with on your own? Are you following the logic I’m sharing here? Next, take a look at the follow up back and forth:
Note their initial response. They’re working down the right path of conceptualizing areas they feel they can find edge, which is precisely what traders should be doing. The key takeaway here is markets have been around for hundreds of years. As a newer trader, the likelihood of stumbling across an easy source of edge is low. While the new trader, might think “what? vol surfaces aren’t easy!” remember, ease is not calibrated to YOU.
Finally, take a look at this other side convo. Again, conceptualize your own response to their post FIRST, then read mine. We’ll circle back on the takeaways.
This an an artifact of this person feels understanding pricing is hard by itself - so if you overcome that difficulty, there should be a reward. Here is an example, where again, someone is framing the game from their own perspective. They feel understanding how something is priced is enough to create edge. The problem here, is again, think of the implication. If that’s ALL that was required for edge, why would there still be one. Below, my response to them.
Options are awesome. Trading is awesome. It’s not easy. Have fun, make some money.
Be an Outlier
Erik
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The content presented is for informational purposes only and any opinions, news, research, analyses, or other information contained are provided as general market commentary and do not constitute investment advice. Outlier Trading, its affiliates, and employees are not responsible for any investment decisions made based on the information presented. We do not guarantee the accuracy, completeness, or reliability of any information presented and are not liable for any losses or damages arising from the use of or reliance on this information. By accessing this content, you acknowledge and agree to these disclosures and terms of use.