At the hedge fund level, options’ trading is about correlating the drift in market volatility with the magnitude of theta decay. At the retail level, the story is always, “I follow the charts very closely then predict the market. Still no success. What should I do”? The answer is simple, how can you predict, a non-linear component like volatility. This is why trading options, based on a chart pattern is stressful and leads to loss of capital. This phenomenon applies to both option buyers and sellers. In today’s article, we shall look at the things that hedge funds do differently.
Trading Without Cognitive Bias
A cognitive bias is an error in thinking. It impacts the decisions that traders make by a huge margin. Some of these errors take place because traders are often driven by memory or historical charts. Look at it this way, I tell you since it had rained heavily in Mumbai on 10th July 2022 so it will rain heavily again on 10th July 2023. This is cognitive bias. So what is the solution? To overcome this challenge, we use the covariance between theta and vega during the live market. The way we do it is simple, we connect our trading software to a live data feed and extract the information during live market hours. The idea is to trade alongside the market maker.