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Hey, that's a good name for it: "The BS Model". I like that one! :-)
You guys obviously know more about this than I do, so I'll point out just a few items:
1.) The idea of "tracking" is implicit in the model. That the "tracking of positions left a lot to be desired" is an implicit condemnation of the model. If the models are correct, then arbitrageurs will cause tracking to occur. How can it happen that tracking does not occur if the models are correct? Are you saying that the arbitrageurs passed on an opportunity for profit?
2.) The idea that the BS model is right "90%" of the time is an indictment of the model. The model is bogus BECAUSE it does not account for the other 10% of the time. The model assumes continuous randomness... this is its flaw. And this is what led to the LTCM debacle. Brownian motion is not an accurate description of price movement. Period.
3.) Someone said that LTCM's undoing was their failure to "ACKNOWLEDGE THE PROBABILITY OF A REALLY BIG WAVE". Wrong! Do you think that someone knew more about the probabilities than the professors? The model implies certain probabilities. Those probabilities were well known to the professors (in fact, the probabilities were included in some of their annual reports). The fact is, the probabilities implied by the BS model are simply not correct models of reality.
4.) Someone said that the LTCM debacle was caused, not by the model, but by LTCM's failure to "IMPLEMENT A CIRCUIT-BREAKER STRATEGY". Don't you get it? Implementing a circuit breaker strategy would be to change the model. The professors' undoing was that they took their model seriously. They traded it exactly as it said to trade. And it was wrong. Saying that the model needs a circuit breaker means that, as it stands, the model is wrong.
To quote from May ("Nonlinear Pricing", p. 7), discussing the concept of "volatility" as defined by the BS model:
"Thus, variance is the second moment of a distribution. If we assume a normal distribution, then the second moment is finite; in other words, it exists. If we actually measure the returns of the stock, like Eugene Fama did in 1963, we discover that returns of a stock are not normally distributed, and that the tails of the distribution do not touch the X axis, and therfore variance is infinite. In other words, it does not exist. Poof! There goes volatility as we know it."
Good trading,
OM
At Wed, 25 Jul 2001 09:16:49 -0600, cwest@xxxxxxxxxxxx wrote:
>Just to add another 2 cents worth (from someone who was in that mix at the
>time). When the coefficients of the spreads broke down, it was too late to
>cover, and the tracking of positions left a lot to be desired. Even the
>lenders (who provided much of the leverage) didn't know what to do, except
>close everything which would have created an unacceptable level of disorder
>in the markets. The fiasco had very little if anything to do with the BS
>model.
>
> -----Original Message-----
>From: M. Simms [mailto:prosys@xxxxxxxxxxxxxxxx]
>Sent: Wednesday, July 25, 2001 9:03 AM
>To: omega-list@xxxxxxxxxx
>Subject: RE: Optionetics
>
>re:".. The effect of applying the Black-Scholes assumption in practice is
>illustrated by the Long-Term Capital Management fiasco."
>
>not true omega man.......their strategy was based on "reversion to mean" of
>volatility.
>In other words, their backtesting was done with fairly consistent and
>confined waves where volatility would rise, then fall.
>All they did was ride these waves...and it was tremendously
>successful......until a really large one hit them.
>IT WAS THEIR FAILURE TO :
>1) ACKNOWLEDGE THE PROBABILITY OF A REALLY BIG WAVE
>2) IMPLEMENT A CIRCUIT-BREAKER STRATEGY
>
>THAT WAS THEIR UN-DOING, NOT THE MODEL.
>
>
>> -----Original Message-----
>> From: the_omega_man@xxxxxxxxxxxx [mailto:the_omega_man@xxxxxxxxxxxx]
>> Sent: Wednesday, July 25, 2001 7:26 AM
>> To: bjeckert@xxxxxxxxxx; omega-list@xxxxxxxxxx
>> Subject: Re: Optionetics
>>
>>
>> At Thu, 19 Jul 2001 14:25:11 -0500, Brian Eckert
>> <bjeckert@xxxxxxxxxx> wrote:
>>
>> >>I attended the Optionetis workshop this week. A few of you expressed
>> >>interest in what I thought of it.
>>
>>
>> I noticed that John Lothian asked you whether the "results" of
>> some strategies presented at the workshop were hypothetical or
>> actual. Did you reply to his question?
>>
>> Many of the current options "strategies" taught by various
>> options gurus are based on Black-Scholes notions of "volatility".
>> I suggest caution in applying such option price "models".
>> Stated simply, the assumption of Gaussian distribution of price
>> changes is incorrect. Thus, the Black-Scholes model is simply
>> bogus. (The more accurate price change distribution, with its
>> infinite "fat tails", negates Black-Scholes as a valid model.)
>>
>> For a more complete discussion of this, see "Nonlinear Pricing",
>> by Christopher May.
>>
>> The effect of applying the Black-Scholes assumption in practice
>> is illustrated by the Long-Term Capital Management fiasco.
>> Scholes and Merton (Black is deceased) used the Black-Scholes
>> assumptions at LTCM. Read "When Genius Failed", a book recently
>> mentioned on this list, for more on this.
>>
>>
>> Be careful out there...
>>
>>
>> Good trading,
>>
>> OM
>>
>>
>>
>> At Thu, 19 Jul 2001 14:25:11 -0500, Brian Eckert
>> <bjeckert@xxxxxxxxxx> wrote:
>>
>> >I attended the Optionetis workshop this week. A few of you expressed
>> >interest in what I thought of it.
>> >
>> >They present a good, clear explanation of how to make low risk,
>> high-reward
>> >options trades. The trades are categorized, the risks are
>> explained, they
>> >teach you the exact way to place the order, etc.
>> >
>> >I have not started to trade using these techniques, but I am
>> >encouraged. Their "calendar spread" technique averaged a 300% return on
>> >equity last year.
>> >
>> >I was bothered by one thing. Throughout the seminar, they pitched their
>> >other seminars, web site, newsletters, etc. I would have been a
>> bit more
>> >comfortable if the seminar came with a 4 week free subscription to their
>> >news letter.
>> >
>> >A friend of mine attended. He recently purchased OptionVue. In
>> looking at
>> >the "platinum" service of their web site, he said that he would have
>> >preferred using it to OoptionVue.
>> >
>> >You may also be wondering if I think George is honest, i.e., does he use
>> >these techniques in his trading, or he is just hawking a system for the
>> >sake of the money he can raise from these workshops. I think he really
>> >trades them.
>> >
>> >Hope this helps.
>> >
>> >I'll let you know what success I have when I begin trading options.
>> >
>> >
>> >
>>
>> At Thu, 19 Jul 2001 14:25:11 -0500, Brian Eckert
>> <bjeckert@xxxxxxxxxx> wrote:
>>
>> >I attended the Optionetis workshop this week. A few of you expressed
>> >interest in what I thought of it.
>> >
>> >They present a good, clear explanation of how to make low risk,
>> high-reward
>> >options trades. The trades are categorized, the risks are
>> explained, they
>> >teach you the exact way to place the order, etc.
>> >
>> >I have not started to trade using these techniques, but I am
>> >encouraged. Their "calendar spread" technique averaged a 300% return on
>> >equity last year.
>> >
>> >I was bothered by one thing. Throughout the seminar, they pitched their
>> >other seminars, web site, newsletters, etc. I would have been a
>> bit more
>> >comfortable if the seminar came with a 4 week free subscription to their
>> >news letter.
>> >
>> >A friend of mine attended. He recently purchased OptionVue. In
>> looking at
>> >the "platinum" service of their web site, he said that he would have
>> >preferred using it to OoptionVue.
>> >
>> >You may also be wondering if I think George is honest, i.e., does he use
>> >these techniques in his trading, or he is just hawking a system for the
>> >sake of the money he can raise from these workshops. I think he really
>> >trades them.
>> >
>> >Hope this helps.
>> >
>> >I'll let you know what success I have when I begin trading options.
>> >
>> >
>> >
>>
>
>
>
>
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