Sep21-W4: The edge is in selling ATM options during mean reversion
Since I began wannabebull model, the biggest skepticism which I have been having is that option sellers win 90% of the time but lose it all during bad time. I know I am human and I will make the mistakes which will make me lose all profits. I have already made many such mistakes and this website has kept track for all of them.
The only way to counter this inevitability is to make an equivalent big gain once in a blue moon. The conventional approach of traders is to trade with trend. Basically, hold something and watch it grow over time. This does not work during option selling. Even if I roll-in strikes, the ROI will not be extraordinary.
There is only one way to make extraordinary returns in option selling. Sell as many near the money strikes as possible when you know mean reversion is inevitable. This is easier said than done of course. It literally means catching the top which is a mission impossible.
But high-risk-high-reward is the name of the game. I think I can play this game with following couple of hypthesis
- If price is above average on both higher timeframe and lower timeframe. Additionally, EMA crossover on lower timeframe should not have happened recently. Target here is smaller EMA of intra-day timeframe
- Divergence on higher timeframe with target being smaller / bigger EMA of higher timeframe depending on divergence indicator’s look-back period.
Both above hypothesis require some more back-testing and custom indicators. I shall be doing that next week. This is worth the effort because ROI is sky-high. Such occasional ROIs can super help in the long run. Also, if I get good at trading mean reversions, I shall be day trading with such setups.
The only catch here is that no matter how thorough I get with my mean reversion setup, I won’t be able to catch top. Therefore, the trade will have multiple entries. I will have to build my short positions. one after the other. Here, ATR can help in knowing when to average my entries.
The theory is fail-proof only if I have unlimited capital. I hope I never again run into a situation when I hit the tilt.