Thursday shopping list

Trading is not difficult - it is just random.

We've had a lengthy debate on social media about the Variance Risk Premium in extremely short-dated options when the volatility regime was exceptionally low. To our surprise, our interlocutor found it difficult to understand that while trading 1 DTE was unsuccessful in SPY, other products were profitable. There's some truth to the notion that the VIX provides an idea of the overall premium in the market, but each product has its own life.

Retail traders have an advantage over pros because we can trade whatever we want! Not taking advantage of this is like trying to row across the ocean when boats exist.

This is less of an issue when the VIX is 18, and the regime is neutral. Premiums in short-dated options are now inflated, making it easier to be profitable if, and only if, you focus on a product with some VRP present.

If you've been a Sharpe Two reader for a while, this may seem obvious, but we'll reiterate it - selling options is not a surefire way to make money. You have a higher chance of being profitable (about a 60% chance when you sell a straddle) and a slight positive expectancy. However, this is not enough to make a living if you don't identify products the market currently overvalues.

While we usually don't spend too much time discussing the Variance Risk Premium in our Thursday Shopping List, we select tickers where it has been present recently or almost always. We also check how the trade has performed lately. There's some predictive power here—if something has worked in the recent past, it's likely that if market conditions don't change, it may also work in the near future.

However, this is not the magic sauce either, and a big part of success in trading is accepting that it's a fairly random process (this is where we agree with that Redditor).

Risk premiums are much harder to predict than a hard science event, like an eclipse or the rate of heat diffusion in a material. Risk premium harvesting is very different from what top-tier market-making and HFT firms do, analyzing complex order book dynamics and deriving much more certainty in what will happen over the next few seconds.

Perhaps this is because trading is not a hard science. Once again, it sounds obvious, but looking at the market as if it's just one big equation waiting to be cracked with something as elegant as E=mc² seems unrealistic, much to the disappointment of many young quants we've spoken with.

To be honest, we prefer it this way. The element of variance makes it more exciting (well, not so exciting sometimes, we admit).

With that in mind, let's dive into this week's list.

The rules

Before we start, let’s do a quick round-up about the rules.

• Short an ATM straddle in the 1DTE contract 19/04 as close as possible to Thursday night's close. In all our metrics and charts, we assumed an execution at 3.50 p.m., but the entry timing doesn’t matter too much: avoid getting in too early, but getting in too late gets you less premium.

• Exit the position as close as possible to Friday's expiration. Again, we assume an execution at 3:50 p.m., but depending on your risk tolerance and satisfaction with the returns, it can be useful to manage the position earlier.

• One word of caution: if you get assigned, leave the trade altogether and eliminate the underlying. If you decide to keep it and “sell premium against it,” it is at your discretion and outside this strategy's scope. It’s okay to keep the other leg expiring out of the money; there is no reason to pay an extra dime to your broker. Ensure it is far enough from any post-market move — the settlement happens at 4.15 pm, not 4 pm.

One last thing— our Discord community is now burgeoning. We monitor this strategy, as well as many others mentioned in this newsletter. Contact us if interested, and we will share the pricing details.