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Positive Expected Value

 Factors
 The program consists of writing short (selling) call and put option positions with the goal of
profiting from time decay. The approach, in and of itself, is similar to the one used by
insurance companies across the globe. Just like an insurance company, you will have to pay
out from time to time. Remember,however, that insurance companies profit by collecting
many premiums, but only paying out on a few.

Option Selling Strategy

 The premium collected, when it triple in value, will result in a loss

of -1% of the account.

 Profit targets (80% of premium received)

 Probability of success (+85%)

 Diversification: 20 to 30 different underlines.



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 Expected Value
The expected value of this strategy, before we start the month, since we sell
options with delta <15
(and or a probability of expiring out of the money > 85%)
has an expected probability of win of 85%.

For Example in a $100,000 account the premium that we want to collect, when
selling options is $500 and take profits when it reach 80% of this value, which
is a profit = $400 or stop loss when it triple in value, to $1500 we will buy to
close the options, which will result in a loss of -1% of the account or -$1000 (=
price that we need to pay to buy back the options, minus the premium received
= -$1500+$500)

Expected Value=Probability Win * (PROFIT) + (1-Probability Win) *(LOSS)

Expected Value per Trade: $400*85%+ -$1000*15% = $190

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 Drawdowns
(Magnitude and Frequency)

Using loss management at 2X the initial credit received means that potential
losses equal a -1% of the account per contract.

We expect to take these losses 10% of the time, Since the Expected
Movement of the underline usually is 4% more than the actual movement

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 Three Key Concepts
 Probability

 Mathematical Expectation

 The Law of Large Numbers

 Expectation of a bet
“The mathematical expectation of any bet is computed by
multiplying each possible gain or loss by the probability of
that gain or loss, then adding the two figures.”

Probability Win * (PROFIT) + (1-Probability Win) *(LOSS) =

Expected Value

 Coin: (1/2) ($100) + (1/2 ) ($-100) = $0

 Roulette:(1/38) ($35) + (37/38 ) ($-1) = $-.0526
 Option Writing (85/100)($400)+(15/100)(-$1000)=+$190
 Expectation is additive
E ( X 1 + X 2 + .... X n=
) E ( X 1 ) + E ( X 2 ) + ....E ( X n )

“The only way to achieve a long term expected

profit betting is to make net positive expectation
bets.”
 Mathematical Expectation
(Expected Value)

Idea first attributed to Dutch

mathematician Christian Huygens

Defined as the weighted average of

a random variable Christian Huygens
n
E ( X )= p1 x1 + p2 x2 + ... + pn xn= ∑px
i =1
i i
As the number of trials increases, the expected ratio
of successes to trials converges to the expected
result.
 Option Time Decay
Time Decay of an option begins to accelerate in the
last 30 days before expiry
Time Decay from Day 120 to Day 90 (Least Impact)

Time Decay from Day 90 to Day 60 (Slightly Greater)

Time Decay from Day 60 to Day 30

(Greater Still)

Option Time Decay from Under

Value 30 Days Prior to Expiry
(Most Rapid)

120 90 60 30 0
Days Days Days Days Days
Time Remaining Until Expiration Date
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 Option Selling Strategy

 Execute the sale of short term date, far out of the

money derivative contracts

 Expiration is between 35 to 60 days

 Target a win rate of +85% on all contracts written

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 Renaissance Technologies

https://www.hsgac.senate.gov/imo/media/doc/STMT%20-
%20Renaissance%20(July%2022%202014)2.pdf

One of the most successful hedge fund in history

the describe their business model, as a +expected value

The model developed by Renaissance for Medallion makes predictions that are
profitable only slightly more often than not. Moreover, the predicted price movements
can be easily overwhelmed by external events. To compensate for these factors, the
model generates a large number of recommendations, so that by virtue of the
mathematical principle known as the law of large numbers, the variability of the
returns produced by the model is greatly reduced.