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Politics : Ask Michael Burke -- Ignore unavailable to you. Want to Upgrade?

To: Night Trader who wrote (32721)	9/22/1998 10:25:00 PM
From: Knighty Tin	Respond to of 132070

Martin, There is no question that option sellers have no clue about the risks they are taking. So, yes, the premiums on both puts and calls favor the smart buyer over the long run. The option formulae are, of course, nonsense. Black-Scholes is the granddaddy of them all, and Myron Scholes just blew up a hedge fund using the silly stuff. Other than my cranky belief that the world is not a mathematical creature, here are the reasons that the formulae are dangerously flawed: 1. The prices do not give enough weighting to the possibility of discountinuous pricing. 2. The inputs on eps, risk free rate, betas, etc. are a perfect example of garbage in/garbage out. No formula works if you are using unrealistic inputs. And, since most option geeks use consensus #s, rather than doing the hard grunt work of figuring out what is really happening for themselves, they get #s that are out to lunch. 3. The crowd uses pretty much the same formulae and the crowd is always wrong once a mass of trades are netted. Someday, check the turnover of traders at the CBOE. Pretty gruesome. 4. The formulae do not consider the table max. Since options have actual position limits for institutions and practical cash limits for individuals, you can and will eventually run out of real estate before probabilities turn your way, even if you are right. Buyers simply have a debit to worry about, not margin calls or infinite upside risk and near infinite downside risk. 5. Insiders will destroy the most meticulous quant jock. If you are selling options to Bill Gates or Michael Dell, through proxies, of course, the odds are you are not going to do well on MSFT and Dell. I am just using those two nerds as examples, not saying that they have ever done any trades in the options markets. The good news is, sellers win more often than buyers. The bad news is, when they lose, they lose big. It is sort of like the guy who bets red at roulette and doubles up when he loses. He wins a lot. But when he loses, hello hard streets. MB