# Growing pains



## Fox (29 August 2009)

I'm new to this forum and a novice options trader. I can contribute by documenting my painful series of mistakes as I bungle and fumble while learning to walk. This is stale news to the old pros here, but should be helpful to over eager novices like myself.  

*BUNGLE 1 - Over Scalping Gamma Scalping*
I read about gamma scalping and it sounded too easy. Instead of doing paper trades, I like to put real money on the table as I'm too eager. You can google pages that describe gamma scalping. However, they don't tell the whole story unless you have a good options trading book and you bothered reading it. In hindsight, after reading Cottle, I now understand my cardinal sin. 

The scenario is as follows. You have a straddle that is slightly profitable when the price has risen slightly ie. you have generated some delta. The idea is that you can short some underlying such that you become delta neutral again. Sounds easy, I thought. I then worked out how many deltas I had generated and sold the equivalent number of stocks to be delta neutral. So far, so good.

The price started going up. I tried to liquidate my entire position as I could have exited profitably. But the market maker (MM) from hell refused to bite. His best offer was going to take a huge chunk of my profit. "To hell with the MM. I'll just scalp more gammas", I foolishly thought. So, I shorted even more underlyings. 

This went on for 3 days. Suddenly, the underlying price exploded even higher. My calls were going for parity. I thought I surely can get out now as the MM can't screw me any further. I was letting my calls go for zero extrinsic value. To my horror, I could not close my position with a decent profit at all. "Where's all the gamma scalping theory gone to?", as the thought raced through my mind and I panicked.

I'm stuck. I can't exit with a decent profit. Why? 

My options bible (which arrived after I got myself in this mess) provided the enlightenment. When you short your underlying, you are effectively reducing your calls and increasing your puts. If you keep scalping more gammas as the price goes up, you will end up being the equivalent of having less and less calls and more and more puts in your straddle. Pictorially, imagine your straddle tilting to the right. The saturation point is when your equivalent position is zero calls and all puts. You have converted your straddle into pure OTM puts. Worthless puts !!!!! 

That's what happened to yours truly. From a 5 put/5 call straddle, I ended up with the equivalent of 9.5 put/0.5 call straddle.  

*Novice lessons learnt:*
1. Gamma scalping is more that just shorting shares when price goes up. There is a limit and you should be aware of that limit ie. don't scalp till kingdom come.
2. Understand what synthetic equivalence means. I mean, really, really understand it. It is vital to understand that your straddle has morphed into a pure OTM put.
3. Gamma scalping should be used to reduce/compensate for your rotting theta. It should not be used to make money.
4. MMs should be hung up to dry and have their testicles fed to flesh eating monkeys .

It hurt. It really hurt. It still hurts. I walked away with crumbs when I could have had the whole cake. But it was worth it. I learnt more than any $3000 course could have told me. It only cost me my pride and my cake. 

Next episode: Why I gamma scalped in the first place.


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## Fox (30 August 2009)

I have since learnt that gamma scalping should be mainly used for compensating your losses due to time decay, and not for generating profits. Of course I did not know that then. Despite that, I really stumbled into this strategy not by intention but as a consequence of another problem.

*BUNGLE 2 - Not all option markets are liquid*
When reading books about options, you do not question certain assumptions. I had this naive notion that the market will always be there. I have read that market makers (MM) are there to be the buyer when you want to sell, and be the seller when you want to buy. In exchange, they will quote you a low bid price and high ask price, much like a money changer. I also believed that there was some sort of market regulator that will ensure that the MM will always take your trade. In other words, I can buy or sell whenever I wish.

My straddle from hell taught me that this is not always true. My original intention was to profit from a very imminent rights issue of XYZ. You could smell the greed in the air. I wanted a piece of the action too. I decided to buy an OTM bull call to take advantage of the expected price surge as punters stampeded over each other to get in before trading halt. 

I put an order in for my bull call spread at the start of day. I offered to pay quite a bit above fair value because MMs had to eat. I watched the price surge before my eyes in the first hour of trading. To my disappointment, there was no MM to take my trade. I watched my potential bull call spread triple in value in an hour, as it slipped further and further away from my reach.

I decided then to abandon the bull call and initiate a straddle instead. Both the put and call were ATM and therefore liquidity should not be an issue. I was correct as the straddle was sold to me just slightly above the mid price. The next day, a trading halt was announced. XYZ announced a rights issue. Bingo! I had a punt each way with my straddle. So I thought I had a good chance to exit the straddle profitably.

After trading halt was lifted a few days later, the options market for XYZ appeared dead, like the last 1/2 hour of trading after the underlying has stopped trading. There were not continuous quotes from the MM. I was not alarmed because I knew that the ASX was adjusting the contract size and strike price to reflect the adjusted value of the underlying due to the rights issue. I assumed that the MM will not act until the adjustments were made.

The underlying price surged after trading halt. I know that my straddle was profitable but did not know the exact amount because the adjust strike and contract price were still unknown. I waited patiently for the ASX announcement of the adjusted option strikes.

On the morning after the options adjustments were made known, I quickly put in a sell order to liquidate my straddle which was fat with profits. To my horror, the MM was not quoting/trading. Not just my trade, but everybody else's trade. The MM was not quoting or trading until about 11.30am. I had thought that MMs had some sort of obligation to buy and sell during market hours. But I have since found that this MM in particular, starts his trading day at random. 

This time, I watched by profits dwindle to zero between 10 am to 11 am. Where was the MM when I needed him? Did he have a late night out? Was he dropping his precious darlings off to school? Was he in the toilet farewelling last night's beef vindaloo? I can only speculate. But my losses were real .

By the time he started quoting again, it was 11.30am and I lost my profits a second time. That was why I resorted to gamma scalping as a consolation prize. As stated in my previous post, it went pear shaped very quickly.

*Novice lessons learnt:*
1. There is no guarantee that the MM will be there when the market opens.
2. Corporate actions sometime result in the options market being in limbo.
3. If you must trade ETOs, pick the most liquid one.
4. I now understand why the pros here prefer to trade index options.
5. Bottom line is that you have no control over market hours and liquidity. You are at the mercy of the MM.


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## wayneL (30 August 2009)

Well done Fox, you are on the right track. 

Re liquidity: Aussie options are notoriously illiquid and the MMs notoriously reticent to play fair. If you can stand the night shift, check out US options. Astonishingly, American MMs are far more eager to deal with you, for a number of reasons.

Re gamma scalping: This can be used for profit with some changes in philosophy and technique, but the setup must be "right". Perhaps I'll start a thread on this one day. But trading gamma on the Oz market? As you have learned - fuggedit.

Welcome to the derivatives forum, you have obviously put some time into learning.

Cheers


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## cutz (30 August 2009)

Hi Fox,

Thanks for sharing,

Yeah i've been squeezed by MQG series a few times, the dumbest was a fat finger error buy to open instead of a sell to open, i didn't reverse the trade because i didn't want to pay up and now i'm left with some lottery tickets.

XJO options are definitely the go if you plan to stick to the aussie market, the only oddity is the deep ITM's sometimes tend to trade below parity due to the fact there's no tradable underlying instrument  but to me it's not really a big deal, sometimes it's worked to my advantage (i've only noticed this on front months).

You may have already figured it out but if you're long a WTFITM call, shorting the underlying (if possible) and exercising could be a more attractive method of closing the position.


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## Fox (30 August 2009)

wayneL said:


> Well done Fox, you are on the right track.



Coming from the master morpher himself, that means a lot to me. Thank you.



wayneL said:


> If you can stand the night shift, check out US options.



Like most before me, that seems to be the inevitable path. 



wayneL said:


> Re gamma scalping: This can be used for profit with some changes in philosophy and technique, but the setup must be "right". Perhaps I'll start a thread on this one day.



I for one and I'm sure everyone else in this forum, is waiting with bated breath.



wayneL said:


> Welcome to the derivatives forum, you have obviously put some time into learning.



Thank you again. I have put in the hours and will need to put in a lot more. I have taken your advice to learn the greeks, dissection, synthetic equivalence etc. Your posts here have inspired me. Every line you have written here has been laden with truth, value and mystery. I think I speak for all, in saying that you have been most generous.


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## Fox (30 August 2009)

cutz said:


> XJO options are definitely the go if you plan to stick to the aussie market,



Thanks Cutz. That was going to be my next plan of action. I recall your previous post where you mentioned that the IB code is AP. I'll find out Monday when I can log it to TWS again.



cutz said:


> You may have already figured it out but if you're long a WTFITM call, shorting the underlying (if possible) and exercising could be a more attractive method of closing the position.



Actual I have not figured it out. Thanks for the tip. I'm sure all newbies will appreciate this. I did read from OTTHR that closing out using the equivalent trade that gives you a better spread is the way to go. But I have not thought about the actual trade itself. So, thanks again.


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## sails (30 August 2009)

Great post, Fox.  

At the end of the day, all the options theory in the world doesn't help with the Aus options market.  I too have lost profits purely to fees and slippage because I chose to do my learning and experimenting during daylight hours here in Aus.  Also influenced by the fact I had been trading the SPI and ASX shares for a few years prior to learning options and felt I had some understanding of the Aus market generally.

However, below is approx what I paid in fees from the day I entered my first options trade in March 2003 to January 2008 when I stopped trading the Aus market for a while.

Aus options brokerage:  $32,800
Aus options ACH fees:  $5,025
ASX data fees (Iress, Bourse, etc):  $11,640

Now, that doesn't include GST as we are registered & we get that back.  Otherwise that would add about another $5000 of costs.

Slippage is another demon.  During those five years, I traded roughly 5000 option contracts (eg a bull call of 5 = 10 contracts).  So, on the assumption of approx 5000 contracts - lets assume 1c slippage.  5000 x 1c = $50.  Multiply that $50 by 1000 SPC = $50,000. That's a whopping $10,000 average per year for every 1c of slippage.  What if it is more - say 2c or 3c....  It's is an extremely underestimated cost which tends to fly under the radar for new option traders.  It did for me for quite a while.

Now, if IB had been available for Aus options trading, those broker and ACH fees would have been roughly less than half.  The fees quoted above were initially $75 minimum - then I changed brokers and got them down to $40 min. and then later to $26.  So, if adjusting only one or two, the minimum fee had to be paid.  And it would have been better to experiment with new strategies with only one or two contacts rather than go bigger to try and average out the fees.  But then IB have their issues - they had negative pricing for Aus options when I started with them (it's finally fixed now) - but a very confusing IB spread description cost me another $3k.  Some MM would have had a party with that one.  Also, IB only give one level of market depth for options - that makes slippage very risk and very likely negates any benefit of fees.

Sadly, I haven't been able handle the night hours to trade the US due to a family situation which eventually took up most of my time (and still does).  Even if I had the time, I would be very reluctant to go back to Aus option trading due to the above.

I ended up narrowing my trading down to BHP and the 4 banks - but even with BHP the MMs are very choosy when they decide to quote.  The only helpful thing is other retail traders which sometimes make it possible to get a better price - but it takes a bit of skill and not showing your hand too much!  And one can't rely on other retail traders popping up to take the other side, so it's pretty risky.  

Maybe there should be an options action group to try and fix the issues of slippage and choosy quoting that goes on, but I think the fat cats like their easy cream too much.  I don't object to MMs needing to make some money along the way, but I do object to being ripped off.

So, take care with the Aus options market.  I often liken it to being a small fish in a  pond full of large sharks.


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## Fox (30 August 2009)

sails said:


> Great post, Fox.



Thank you. I can only contribute my bungles at the moment. And there's plenty of it .



sails said:


> That's a whopping $10,000 average per year for every 1c of slippage.



This is often overlooked by novices. When I realized it myself, I felt anger and then followed by resignation. 



sails said:


> Also, IB only give one level of market depth for options - that makes slippage very risk and very likely negates any benefit of fees.



Had not thought about that. I will need to think about this more.



sails said:


> I ended up narrowing my trading down to BHP and the 4 banks



I initiated my first single contract butterfly on Friday with CBA. I managed to get the order filled at $0.007 above my assumed fair price. ie. $7 going to the pocket of the MM. The problem was that order price increments were in $0.005. When I offered $0.002, the MM did not bite. He took the next one.



sails said:


> ... but I think the fat cats like their easy cream too much. I don't object to MMs needing to make some money along the way, but I do object to being ripped off.
> 
> So, take care with the Aus options market. I often liken it to being a small fish in a pond full of large sharks.



Yes, MMs are a law unto themselves. We live in a world where stealing 1c over thousands of times is not a crime, but stealing a loaf of bread can lead to a prison sentence. The banks, the government and MMs do it with impunity.


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## Grinder (30 August 2009)

My sentiments exactly to all of the above post and like many others have given Oz options the flick last year (hopefully never to return). Zero sum, negative sum gets thrown around alot, rightfully so. If you trade Oz think it should be more like beyond negative & then some.

Fox, well done for sharing. I'm sure it will help many who visit retain some of their hard earned before getting fleeced, as you know theres no quick & easy way to the riches and that anything worth doing is usually going to be difficult, options trading is no exception. You seem like a quick learner, unfortunatly I'm not & endured some consistent punishment courtesy of the MMs. Im glad I did as hard lessons taught are the ones best learnt.


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## Fox (31 August 2009)

Grinder said:


> Im glad I did as hard lessons taught are the ones best learnt.



I'm with you on this. All the reading and paper trading cannot replicate the feeling the sting of your own mistake. In my folly with gamma scalping, I "felt" the loss gamma first hand. My appreciation of the greeks (gamma at least) doubled overnight. Gamma is no longer theoretical but practical to me now.


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## sails (31 August 2009)

Fox said:


> I'm with you on this. All the reading and paper trading cannot replicate the feeling the sting of your own mistake. In my folly with gamma scalping, I "felt" the loss gamma first hand. My appreciation of the greeks (gamma at least) doubled overnight. Gamma is no longer theoretical but practical to me now.




This is so true.  Studying the greeks is initially quite daunting and mind bending.  I'm not a quant either, so I know how hard it was - but I also remember how rewarding it was when the lights came on!  Then to see them in action and understand the factors that are driving the option price is absolutely the cream on the cake.


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## sails (31 August 2009)

Just noticed this on the ASX site: http://www.asx.com.au/products/pdf/notices/2009/Clm10709.pdf
ACH fees are to increase from $1.02 to $1.30 (exclusive of GST) as from 1st September, 2009:  

Continues to confirm my belief that they really don't want customers - just newbies to suck dry...


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## NeuromanceR (31 August 2009)

sails said:


> ACH fees are to increase from $1.02 to $1.30 (exclusive of GST) as from 1st September, 2009




A whopping 27.5% increase?!

SCUM!


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## cutz (31 August 2009)

sails said:


> Just noticed this on the ASX site: http://www.asx.com.au/products/pdf/notices/2009/Clm10709.pdf
> ACH fees are to increase from $1.02 to $1.30 (exclusive of GST) as from 1st September, 2009:
> 
> Continues to confirm my belief that they really don't want customers - just newbies to suck dry...




Yeah pretty disappointing,

I guess they must be upping their fees in preparation for when they finally split the contracts, well that's my theory anyway.

Glad they haven't touched the index options (yet).


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## Fox (1 September 2009)

*BUNGLE 3 - Limited Perspective Of Options*

I spent many years searching for the holy grail of option trading systems. I wanted to believe that there is a particular spread, or entry/exit system etc, that will give me a positive mathematical expectation a.k.a the edge. Then I would simply blindly follow the the "system" and over time, the edge will manifest itself.

I now believe that while such systems may exist, they have their limitations. These include:
1. If you do find an edge, and the edge is small, you will need to make thousands of trades over years to realise the profits. Profits will not be consistent ie. you *can't rely on it as a regular income*. For those who can churn the required large number of trades with the edge on their side (like our dreaded MMs), then this will work.
2. If your edge is too small, the costs eg. bid/ask spread and commissions, will overwhelm your edge and you will be a net loser, or break even at best in the long term. I think the term used in this forum is "contest risk". Please correct me if I'm wrong regarding the meaning of contest risk. These systems will be for the big boys with favourable conditions that you can never match.

Now comes the good news. This forum has given me a new perspective on options trading. The clues and hints are everywhere, but only if you awaken to them. A knife analogy will be helpful here. Options are like knives. They come in all varieties: butter knife, carving knife, hunting knife, meat cleaver etc. Trying to find a mindless blackbox system is like trying to use a butter knife for cutting meat, spreading jam, killing a freshwater croc and shaving. No such single knife exists that will do all that. It is better to find the right knife to do the right job. 

This perspective is simple in hindsight but eye opening if you were previously blind to it. The active forum members have shared this idea for a long time now. For novices, the jargons and options theory seem daunting and therefore may drown out this powerful idea. I humbly admit that I was unaware of this simple idea before finding this forum.

The holy grail is neither black nor white. It is neither left nor right, near nor far. It always lies hidden somewhere in between. Until you change your perspective, you will not be able to dissect the beast and find the treasure hidden in between.


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## mazzatelli (1 September 2009)

The secret is to short WOTM options


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## sails (1 September 2009)

I think the idea of finding the one and only option strategy is largely fed by option educators.  In my case, I felt that the educators would bait by stating the next expensive course would teach a certain secret strategy... lol.

I would then spend hours searching and sifting through option forums worldwide to try and discover this secret strategy without paying the overpriced fees.  And by doing that, I got some pretty good education in options along the way and became quite proficient at testing other people's ideas in the likes of the Hoadley software.  I also learned, as you have just pointed out, that there are many tools available in the option tool box to suit different conditions.  

At the end of the day, we are simply trading puts and calls while attempting to manage the greeks that control them.


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## sails (1 September 2009)

mazzatelli said:


> The secret is to short WOTM options




lol Mazza - that's a bit boring... 

What about the seagull - never did find  out exactly what that was, except I got the impression it has something to do with the look of the risk graph.

And the Tarzan Loves Jane strategy (I think that's what it was called).  I never learned it either, but got the impression it was something along the lines of a double ratioed calendar...


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## mazzatelli (1 September 2009)

sails said:


> And the Tarzan Loves Jane strategy (I think that's what it was called).  I never learned it either, but got the impression it was something along the lines of a double ratioed calendar...




So naughty M...
Does one put these on naked? :casanova: or with limited risk for added protection? 

EDIT: I just saw the responses on Optionetics, choked on my coffee


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## sails (1 September 2009)

mazzatelli said:


> So naughty M...
> Does one put these on naked? :casanova: or with limited risk for added protection?
> 
> EDIT: I just saw the responses on Optionetics, choked on my coffee




What - on the optionetics forum?  Haven't checked back in there for months!

Not naughty at all - just telling it like it was..


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## Fox (2 September 2009)

*Rationale for exit point*

Reading this forum and other sources, it appears that the pros exit their position before expiry. They usually have some sort of target/benchmark to exit eg. 50% of of max profit potential.

There must be good reasons but I can't see why. For example, you have a butterfly initiated one month before expiry. It is now 5 days before expiry and the price is at the sold strike. A large chunk of the profit (approx. 1/2) can be realised in the next 5 days. Why would one exit now and only realise 1/2 the max profit? Why not wait till expiry and get the full profit?

The only reasons I can see are:
1. Exit while the price hovers around the sold strike to avoid the risk that price runs away from the sold strike in the last week.
2. Pin risk.

Are there other more valid reasons to exit before expiry? Or am I making a wrong assumption that professional traders do not exit at expiry? Any comments/words of wisdom/thoughts/enlightenment is much appreciated.


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## mazzatelli (2 September 2009)

Depends on:
1) Individuals risk:reward tolerance
E.g. Condor max profit $2. Max risk $5. Position is +$1.80. Only $0.20 premium to be earned, is the remaining premium worth the risk? 

Charles Cottle: "Would I initiate the position today at these prices?"

2) Position structure
E.g. Iron Condor with short otm strikes. Time decay decelerates for otm/itm strikes during the last week compared to acceleration for atm strikes.

Wayne's Explanation

So exiting these before expiry is more desirable compared to a butterfly

My


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## Fox (2 September 2009)

Thanks Mazza.


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## cutz (4 September 2009)

Hi Fox,

Agree with what has already been said regarding closing out, no point of trying to squeeze every bit of profit only to see the position turn on you, especially since in the final couple of weeks things can get pretty twitchy.

In my case the only things that expire are the occasional leftover hedge/wing that wasn't worth the effort of trading out of, i sometimes have wet dreams of these leftovers exploding in value, no go yet, maybe sep, oct, who knows.

Actually come to think of it i probably would have done better not leaving a trail of leftovers, especially in the last few months.


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## mazzatelli (4 September 2009)

Fox said:


> I now understand why the pros here prefer to trade index options.




Don't be discouraged from equity options due to this one experience. Sometimes there is a lack of premium in index options to justify being short gamma/vega.



cutz said:


> Actually come to think of it i probably would have done better not leaving a trail of leftovers, especially in the last few months.




Thanks for the disturbing imagery LOL 
Are the leftovers from e.g. an IC wing strikes?


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## cutz (4 September 2009)

mazzatelli said:


> Are the leftovers from e.g. an IC wing strikes?




Hi Mazza,

Yep the leftovers were from what i can best describe as an index iron butterfly with slightly overweight wings being constantly moved up over the course of this new bull market.

I got in the habit of leaving put wingstrikes on due to a paranoia of a huge reversal, perhaps not the best decision in hindsight.


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## mazzatelli (4 September 2009)

Ahh I getcha!!!
Always good to possess wing gamma to cover 2 & 3 sigma scenarios IMO
Your paranoia is not misplaced


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## Grinder (4 September 2009)

All depends on the R/R when deciding to hold on. More often than not I'm out a month before expiry but with IBs I can see the logic in holding on longer.

Cutz, hear ya on the wings. My extras are'nt worth the trouble and at times I've morphed em to create a spread to offset some of the cost. Found that loading up on protection when the market is'nt really moving eats into my credit too much so have been adjusting as I go along.


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## brty (5 September 2009)

Interesting thread,

Just remember that the MM are there to make money, not lose it. There is no reason why they should give anyone a free ride.

I gave up options on the Aus market 10 years ago for exactly the same reasons already explained, not enough fools to take the other side of the contract, and the MM is no fool.

There are plenty of different forums on the internet where the "wonderful", option strategies are promoted. However they assume a liquid market traded at a reasonable price, not true in the real world.

brty


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## wayneL (5 September 2009)

brty said:


> IHowever they assume a liquid market traded at a reasonable price, not true in the real world.
> 
> brty




There are liquid options markets in the real world; just not in Oz.

Here is a run of the mill large cap I just happen to be trading atm (FCX)... and there are many that are far more liquid than this.


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## Fox (5 September 2009)

mazzatelli said:


> Don't be discouraged from equity options due to this one experience.



Mazz, the one experience in my earlier post was a really, really illiquid case (in hindsight). Due to inexperience and over zealousness, I jumped into the trade without checking volume first. I checked the daily trading volume recently, and found that the daily trading volume was only 8 transactions!!! Compare that with BHP which was 3200 transactions. I look at the volume a lot more closely these days.

My first CBA fly was a much more pleasant experience. I got filled in what felt like an instant, and the prices I got were pleasantly close to mid-price and very close to the fair value estimated by the modeller.

Wayne's TWS screenshot of FCX has got me drooling. I had to take a second look to confirm that they were option spreads and not Aussie share spreads :. Really tempted to trade US options but always have this fear about complications with Aussie tax returns. To guys like Grinder who have switched to the US market, has filling your tax return been made any more complicated as a result of trading US options? Or was this a fairly smooth transition ie. trading AUS options or US options did not affect how your tax returns were prepared. Again, any advice is much appreciated. Thanks.


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## Fox (6 September 2009)

*BUNGLE 4 - Too cheap to spend on tools*

Like a lot of things in life, you get what you pay. Buy a cheap wrench from China and you will not undo that rusty nut or bolt. Buy any cheap tool and you will not get the job done.

Likewise with options. When I first looked at options, I found that two types of trading tools were offered for retail customers. The first was the typical web based order entry tool which was "free". The second was the "expensive" ones like IRESS. I used the terms "free" and "expensive" in relation to dollars paid to the broker.

In hindsight, if you define "free" and "expensive" in terms of getting a good price from the MM, then the "expensive" tools can be deemed cheap and vice versa. Until I had experienced using TWS from IB, I did not know that I could tango with the MM. Prices and orders had a static (as opposed to dynamic) feel to them. Those cumbersome trading passwords of CommSec and ETRADE gives the same psychological impression of placing a share price in a queue (at least for me it did).

With the benefit of a better trading tool, suddenly the old barriers came down. I could dart in and out with bids and offers, teasing the MMs in a seductive tango. Unfortunately for me, the MM always led and I always followed . At least I could tango now. Before, I just sat in the queue, and only got filled when prices went against me.

I was also cheap on other tools as well. Hoadley's modeller was not "expensive" in hindsight as it is full of features that the "free" modeller from ETRADE did not offer. The level of understanding of my position increased by a quantum amount by having the right modeller.

Lastly, I was too cheap to spend on good books. Actually, that was not quite true. I was willing to pay for good books, but I just did not know where to find them. I do know now that if you go to Dymocks, it is unlikely that you will find the killer option book. It was the ASF that lead me to the good books. The point is, don't be a cheap skate when it comes to good books.

I was too cynical about those $3000 courses advertised on TV, where a flashing green button was a signal to buy. I was too wary about tools and resources that were highly priced. On the other hand, this forum is free, but the content is priceless. This just goes to show that price and value are *not always* the same thing. 

At the end of the day, it is about discernment. It is up to the individual to spot sincerity, understand motive and avoid hype. Are you discerning enough to know if a book or course is good? If you are, then spend on that knowledge. 

*Novice lessons learnt:*
1. Be on the look out for good tools and resources.
2. Pay for them and they will more than pay for themselves very quickly.
3. Discernment is the key. Beware the snake oil salesman.


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## mazzatelli (6 September 2009)

Hi Fox, 
There are many excellent free open source programs, so I do not completely agree with paying up for software/books.

There is a tendency to acquire all sorts of tools when starting out trading. I was guilty of that problem.


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## cutz (6 September 2009)

Fox said:


> *Those cumbersome trading passwords of CommSec and ETRADE gives the same psychological impression of placing a share price in a queue (at least for me it did).*



*

I wish they got rid of the silly thing (trading password), really a trap when rolling spreads in fast moving markets coupled with delays in order approval, once i had to ring them up to find out what was going on.

Anyway these days i do most of my trading through IB, makes a big difference.

BTW, Keep up the posting, it's nice seeing the options threads getting a kick along.*


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## Grinder (7 September 2009)

Fox said:


> Really tempted to trade US options but always have this fear about complications with Aussie tax returns. To guys like Grinder who have switched to the US market, has filling your tax return been made any more complicated as a result of trading US options? Or was this a fairly smooth transition ie. trading AUS options or US options did not affect how your tax returns were prepared. Again, any advice is much appreciated. Thanks.




I've only recently switched to US trading and have'nt yet filed for the 08/09 year in which I have both OZ & US options. I will prepare my speadsheets & all relevant information as per usual and let my accountant know about the US trading, when I find out the exact process with post it up.

In the meantime have a read of http://www.greencompany.com/EducationCenter/GlobalTraderTax.pdf
the bottom of page 4 lays it out best, but be sure to speak to a tax accountant on the matter as I'm told they know best 

If theres any accountants reading, please feel free to provide any info.


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## Fox (7 September 2009)

Thanks for the tax info, Grinder. Any follow up post on this topic will be helpful to those of us newbies venturing into the US, and will be much appreciated.

BTW, I have finished reading Cottle and that thread that you sent me regarding adjustments make a lot more sense now. As always, you have been most helpful. Thank you, sir.


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## Fox (14 September 2009)

*Surviving A.I.D.S*
I'm suffering from Adjustment Intuition Deficiency Syndrome (AIDS) at the moment. I took the advice of starting small when trialling an idea. As such, I bought the smallest CBA fly I could and tried my hand at morphing it. I did not expect to achieve 100% success, but was more of a learning journey. Hence I did not title this post as a bungle, as in my previous posts.

The first thing I found was that adjustments are not cheap. Therefore, I need to budget for them in the future. My fly had such a small profit zone (or width) that a 1% move in the CBA share will cause me to be anxious. Being anxious, I felt compelled to adjust. It has been less than two weeks and I have already made 8 adjustments. At approximately $30 per adjustment, my butterfly is dying from exhaustion. All my losses are attributable to the adjustment costs.

*Lessons learnt:*
1. Get a reasonable profit zone for my fly.
2. Budget for a reasonable number of adjustments. I'll try for 4 in a month for my next trial.
3. Don't be trigger happy but stick to the allocated number of adjustments.
4. Find the most efficient adjustment mechanism.

The next thing I experienced was that the adjustments were not easy to execute. The standard ones like verticals were fairly easy. I only lost on slippage but the execution itself was pretty straight forward. Trying to do a -1/+3/-2 adjustment while prices are bobbing up and down, AND simultaneously battling the MM was close to impossible. I don't have the skills and experience of Sails. The MM beat me into submission. I lost quite a bit there.
*Lesson learnt:*
1. Use simple adjustments for now. Leave the complex ones to when I'm a big boy .

The final problem is one I am not able to solve yet. All adjustments must be done to accommodate a trader's view of the market. I am not a chartist and I don't really have an instinct for the future direction of price movements. Like most, I am responding to greed and fear when prices move in my favour or against me. This is therefore not a view of the market but more a psychological response to price movements. I'll need to resolve this. Any ideas are welcome. 

Although my fly has morphed into something really ugly and is dying a painful death, it served its purpose ie. to educate. I am confident that my next one will be better.


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## Grinder (15 September 2009)

I admire your resilience Fox, it's definitely a craft that takes practice & experience. Can't offer any real guidance on flys (especially with the Oz market where fees & slippage would eat up most of what you make) so will leave that to the others. What I can say in relation to having a view of the market, is I seldom look at charts and try not to have a view of the market, as I can't pick the right direction out of shopping centre car park let alone the market. I prefer to trade as a risk manager, managing my positions as threats to my personal risk comfort zone approaches & making adjustments using the greeks. I know that sounds broad & quite vague but it's pretty much it.


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## wayneL (15 September 2009)

My thoughts Fox:



Fox said:


> *Lessons learnt:*
> 1. Get a reasonable profit zone for my fly. Yes
> 2. Budget for a reasonable number of adjustments. I'll try for 4 in a month for my next trial. Do what is necessary, but as few as possible. This part is more art than science. Ideally, zero is the best number of adjustments. Sometimes many are necessary, but the fewer the better.
> 3. Don't be trigger happy but stick to the allocated number of adjustments. Don't limit yourself to a hard number, buts as above, the fewer the better.
> ...




Yes, great attitude.

You can read books, do courses and get _au fait_ with all the concepts. That is essential, but there is no substitute for experience. You're going the right way about it, you'll find a way that suits *you* best.

My story this month is that if I had done nothing, I could have exited with excellent profit and had a festive dinner with friends and family. I made several adjustments however, which trims absolute profit potential... and I don't own a crystal ball. The market could equally have done something unpleasant - it could have been a one way market again.

As a further comment, those bid/ask spreads can be a killer when trading like this. Markets with wider spreads should be avoided or traded in a different way.


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## sails (15 September 2009)

Fox said:


> *Surviving A.I.D.S*
> I'm suffering from Adjustment Intuition Deficiency Syndrome (AIDS) at the moment. I took the advice of starting small when trialling an idea. As such, I bought the smallest CBA fly I could and tried my hand at morphing it. I did not expect to achieve 100% success, but was more of a learning journey. Hence I did not title this post as a bungle, as in my previous posts.
> 
> The first thing I found was that adjustments are not cheap. Therefore, I need to budget for them in the future. My fly had such a small profit zone (or width) that a 1% move in the CBA share will cause me to be anxious. Being anxious, I felt compelled to adjust. It has been less than two weeks and I have already made 8 adjustments. At approximately $30 per adjustment, my butterfly is dying from exhaustion. All my losses are attributable to the adjustment costs.
> ...




Hi Fox, well done on your experiment and totally agree with playing with small lots in the name of education.  And yes, Oz minimum fees are a killer when trading spreads in small lots.  I chose to do my options learning in the Oz market due to it being daylight hours, but certainly paid a high price in fees for the privilege.  

Fees on small lots are where IB shine as they have no minimum.  $3 per contract (that may have gone up a bit since the ASX have raised their price per contract).  With experimental trades with a one lot it would only take about 4-5 trades and I had paid for Iress anyway.  A couple of things to note with IB and spreads - and that is assignment IF you don't have the necessary funds or shares in your account to fulfil the assignment obligations.  I understand (unless it has since changed) that IB only give the first 10 minutes to close the assigned position out before they start randomly closing out positions in the account which may or may not have a thing to do with the assigned position.

The other thing with IB is that customer service can be a bit slow and cumbersome - especially if you have someone whose first language is not English!




> The next thing I experienced was that the adjustments were not easy to execute. The standard ones like verticals were fairly easy. I only lost on slippage but the execution itself was pretty straight forward. Trying to do a -1/+3/-2 adjustment while prices are bobbing up and down, AND simultaneously battling the MM was close to impossible. I don't have the skills and experience of Sails. The MM beat me into submission. I lost quite a bit there.
> *Lesson learnt:*
> 1. Use simple adjustments for now. Leave the complex ones to when I'm a big boy .




Goodness Fox, I hope I haven't given the impression that I get a fair price on every trade - oh I wish...   I have shared some of the methods (aka mind games) I have used, but yes, I have also been beaten into submission on many occasions - usually when it is a deal that has to be done.  If I was that good at getting fills, I would be a bit happier to remain trading Oz options.



> The final problem is one I am not able to solve yet. All adjustments must be done to accommodate a trader's view of the market. I am not a chartist and I don't really have an instinct for the future direction of price movements. Like most, I am responding to greed and fear when prices move in my favour or against me. This is therefore not a view of the market but more a psychological response to price movements. I'll need to resolve this. Any ideas are welcome.




Although I have had a bit of T/A training over the years, I find I am really not much better than 50/50 in picking direction.  I have found FrankD's ebook quite helpful and using his larger timeframe levels for option adjustments has worked reasonably well especially when they cluster with other T/A such as fib levels, range repeats, volume analysis, etc.  Frank goes into a lot more than just his basic levels in his ebook, but personally, I found the basic, longer term levels a useful tool for me.  I also watch put/call ratios for extremes together with unusually large turnover.  I also often incorporate some basic time analysis - I did start a thread on it some time ago, but haven't had the time to keep it up.  Time analysis can be quite labour intensive and doesn't always work.



> Although my fly has morphed into something really ugly and is dying a painful death, it served its purpose ie. to educate. I am confident that my next one will be better.




Yeah, it's tough learning, but also fun to take on the challenge.  I have done many, many one lots of experimental type trades and it is where I have learned the most about the practical aspect of option trading - especially in Oz!


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## mazzatelli (15 September 2009)

Since you don't trade exclusively off charts [I don't either], maybe forming a view on volatility might be of use to you.


----------



## Fox (15 September 2009)

Thanks everyone for your kind words of encouragement. It can be pretty lonely and scary trading on your own in front of a computer. Your words have helped me so much thus far, and have meant a lot me to. Options trading is definitely not a dinner topic conversation I can have with friends and relatives. I always get dismissed as a gambler or a fool, or (my favourite) a lunatic. My views are always contrary to the majority vote when the topic comes up.

Your replies have spawned so many new points of discussion. I'll reply to each of them in a separate post. I'll start with Grinder. 



Grinder said:


> I prefer to trade as a risk manager, managing my positions as threats to my personal risk comfort zone approaches & making adjustments using the greeks. I know that sounds broad & quite vague but it's pretty much it.



I'm heartened to hear that this approach is plausible. It sounds like an approach that I can attempt. 

Like you, I have been terrible at picking direction. In fact, I'm 90% of the time wrong. So, if I acted the opposite to my instincts, I could be quite successful .

I have followed your old and recent posts with interest and know that your recent upgrade to portfolio margin is a good indication that you are not talking BS. I would love to hear more about your approach in future forum discussions.


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## Fox (15 September 2009)

wayneL said:


> As a further comment, those bid/ask spreads can be a killer when trading like this. Markets with wider spreads should be avoided or traded in a different way.



Good advice. I'll add that to my personal training notes.

I like your approach of adjusting close to the money ICs and flies. I've followed your trail of clues and used in conjunction with the option bible, I think I'm starting to discover more efficient approaches to adjusting these creatures.

Your gems are camouflaged in such innocent one liners in your posts. All the more satisfying when I discover them upon revisiting your posts. Cheers.


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## Fox (15 September 2009)

sails said:


> I chose to do my options learning in the Oz market due to it being daylight hours, but certainly paid a high price in fees for the privilege.



Aside from the daylight hours, I see positives in trading Aussie options. It is a bit like learning how to drive. If you can pass and survive driving in crazy cities like Bangkok, then driving in sleepy ole Perth will be a breeze. Likewise, surviving Oz will make the US seem like a walk in the park, I would imagine/hope.



sails said:


> ... IB only give the first 10 minutes to close the assigned position out before they start randomly closing out positions in the account which may or may not have a thing to do with the assigned position.



Yikes!  Mental note to self: Close out positions before expiry.



sails said:


> Although I have had a bit of T/A training over the years, I find I am really not much better than 50/50 in picking direction.  I have found FrankD's ebook quite helpful and using his larger timeframe levels for option adjustments has worked reasonably well especially when they cluster with other T/A such as fib levels, range repeats, volume analysis, etc.  Frank goes into a lot more than just his basic levels in his ebook, but personally, I found the basic, longer term levels a useful tool for me.  I also watch put/call ratios for extremes together with unusually large turnover.  I also often incorporate some basic time analysis - I did start a thread on it some time ago, but haven't had the time to keep it up.  Time analysis can be quite labour intensive and doesn't always work.



Thanks for the tips re. T/A. I'll keep the name FrankD in mind when I get a chance to investigate T/A further. Can I ask what 'D' in 'FrankD' is? Thanks.


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## Fox (15 September 2009)

mazzatelli said:


> Since you don't trade exclusively off charts [I don't either], maybe forming a view on volatility might be of use to you.



Volatility is a part of the options frontier that I will have to confront. I have been putting it off but at some point, I know that I will need to know more. Right now, I have not reached a point to ask decent questions yet.

With what little I know, I can't figure out how you guys know that a vol rush is upon us. I understand that vol is mean reverting. In other words, after a period of low vol, one can expect vol to increase towards the mean. What I don't understand yet, is, how to determine *when* that reversion to the mean will occur. How do you guys know that a vol tsunami will be hitting us soon? Couldn't vol pick up in say a year's time?


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## sails (15 September 2009)

Fox said:


> ..Yikes!  Mental note to self: Close out positions before expiry.




Not only at expiry - also ITM short calls day before ex-dividend (or other corporate events) can place the position at risk of assignment.  And at any time a short position is ITM, there is risk of assignment especially if there is little extrinsic value left.




> Thanks for the tips re. T/A. I'll keep the name FrankD in mind when I get a chance to investigate T/A further. Can I ask what 'D' in 'FrankD' is? Thanks.




Frank has a thread here at ASF - https://www.aussiestockforums.com/forums/showthread.php?t=6588.  The link to Frank's blog is in his signature - that should answer your questions.  That said, T/A is not for everyone and I think deciding where to adjust becomes an individual thing.  As Mazza pointed out, not all option traders even look at a chart!


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## mazzatelli (15 September 2009)

Fox said:


> What I don't understand yet, is, how to determine *when* that reversion to the mean will occur.




No one knows for sure, but forecasts/predictions are made, and then the appropriate entry & exits are executed [just like for Px]. 

w.r.t methodology there are several approaches you would have come across some in McMillan [iv//hv crossover, vol cones]. Also Wayne's blog has good vola discussion, well worth checking it out.


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## Fox (4 October 2009)

Like its biological counterpart, my A.I.D.S appears incurable.

*Bungle #5: Fooled By Volatility*

I'm at a stage where the significance of volatility is starting to hit home. Honestly, I have been avoiding it like the plague ie. I have been assuming that 

1. volatility does not change significantly during the period my position is open.
2. the effect of volatility is negligible on my position.

The truth was that I was not able to cope nor conquer volatility. Volatility had free reign over me and wreaked havoc to my fly. Why do I think that? Let me tell my story.

From my previous episode, I learnt a few lessons from my CBA fly. I came back for more this month, determined to improve upon the previous attempt. Changes I made were:

1. Increase my profit zone.
2. Minimize my number of adjustments.

*Plan to increase my profit zone*
How should I increase my profit zone a.k.a goal posts? How wide apart should the goal posts be? How about at least 1 standard deviation (sigma) for a weekly period? OK, I'll try that since I don't know any better. 68% probability is something I can stomach.

To determine sigma, I needed the a volatility figure. IV was trading at 27% and HV was shown to be about 24% in my IB TWS option trader platform. To be on the safe side, I'll assume the greater of the two figures and use 27% as my volatility figure. (I now know that IV and HV don't mean sh&t*. Only future volatility matters. But I need a crystal ball for that. Anyone able to sell me one?)

Weekly volatility is derived by 
	
	



```
27%/sqrt(52) = 3.74%.
```
 Convert that to price movement by 
	
	



```
3.74% * $50 = $1.87.
```
 I expect a 1/3 chance that CBA will fluctuate +/-$1.87 from the current price of $50 by the end of the first week. 

To be safe, I planned to initiate my new CBA fly to have a profit zone of +/-$2.50. 

*Plan to minimize my number of adjustments*
I will put in practice what I know about dissection and synthetic equivalence to minimize the number of legs to trade per adjustment. In fact I had great success on this front. During my second adjustment, I managed to reduce my transaction count from 4 to 2 to achieve the new position I wanted. (Woohoo! Well done Fox!!! Your're not just a pretty face ).

Apart from more efficient adjustment methodologies, I believed that my carefully designed profit zone of +/-$2.50 will allow me to sit back and relax for the week. My approach was to:

a. target an average of 1 adjustment a week (and more if necessary) and 
b. make adjustments if the price moved greater than 1 sigma for that week

Since I expect 1 sigma events to occur once every three weeks on average, I should be sitting quietly for two of those weeks. Sounds like a fantastic plan to me. I will avoid the mistake of over adjusting.

*The body is willing but the mind is week*
I know that price movements I calculated were based on expected movements at the end of each weekly period. This would mean that I needed to fill my order for a CBA fly and then go fishing for the rest of the week. Like the scab of a healing wound, I could not resist peeling of the protective covers of my fly. Instead of fishing, I watched nervously as CBA prices darted 1 to 1.5 sigmas during the week. Out of fear, I just could not resist adjusting my positions during those wild sigma swings, only to find that prices whipsaw back to the starting point of $50 after two weeks.

In the mean time, I have locked in a substantial loss of more than 1/2 of my anticipated profit. I feel like an innocent kid spilling milk on the floor and mummy will be bring out the whip really soon. "I really, really, really tried to hold the bottle with two hands, Ma. But the bottle just slipped out of my tiny hands". "That's no excuse Fox junior. You're a stupid, stupid boy! If you spill the rest of the milk, you will have your weet-bix dry tomorrow morning". Fox junior runs off to this room whimpering like a little girl, misunderstood and unloved by mummy.

zzzzzzzz .... Huh! I must have dozed off. Why are you all staring at me like that? Back to option reality again. 

*The devil is in the detail*
How could this be? Should I have stuck to my plan and gone fishing? Would that have helped? In hindsight, yes of course. But were there other more compelling reasons? 

Fortunately, I'm in the middle of reading Natenberg. I read a simple test he proposes to verify realised volatility. As described above, I should expect 1 sigma moves 1 week out of 3. I downloaded the weekly prices from yahoo and did a bit of detective work. The weekly price moves using figures from Yahoo are shown below.

-2.57% 
 4.40% 
 3.08% 
 4.12% 
 1.17% 
 3.61% 
 -7.67% 
 5.62% 
 3.78% 
 7.39% 
 0.66% 
 5.30% 

The numbers in red show that prices moved more than my 1 sigma calculation of 3.74% for *7 out of the last 12* weeks ! Not the 3 out of 12 that I had expected.

I started to have doubts about the volatility figures I adopted. I chose 27% by assuming that the market is intelligent and therefore by voting with their pockets, 27% was a good forecast. I also assumed that the HV from IB was as good as any. I then turned to Hoadley for HV and to my horror, his figure was close to 30%. When I reduced the "window size" to 5, the figures were fluctuating between 20 to 40% in the last two weeks.

So will the real volatility please stand up? I think we will never know. The elusive Miss Volatility has too many multi-personalities, alter egos and proxies that she seems to be everywhere and no where. Too many commentators pretend to tell you that volatility is tangible/concrete. I'm starting to believe that this is not the case. At best, volatility is something you learn to cope and understand through observation.  At worst, it is the escape clause for authors when their strategies fail. Instead of saying that you, the mug punter, failed because you did not have faith, the escape clause is that you failed because you could not forecast volatility. The strategy is right but your forecast was just not good enough. He wins, you lose.

I was well and truly fooled by volatility. I'm only just a pretty face after all . Time to read and learn more. Back to the drawing board.

*Lessons learnt:*
1. Volatility forecasting is paramount. Unfortunately, I don't know how to do it (yet).
2. I need to believe that volatility is forecast to fall during the life of my fly. Otherwise, there is no point putting on a fly. The odds are against me, and you can't beat the odds.
3. If volatility forecasting is only a bet, make sure that I can afford the loss when I'm wrong.


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## mazzatelli (4 October 2009)

w.r.t to vol forecasting [I'm assuming with the engineering bg, you've had exposure to statistics and regression] you *may* find literature on GARCH, ARMA, EMWA models for forecasting vol interesting.

Most of the practical application is not published in academia for competitive edge reasons


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## Fox (4 October 2009)

Thanks Mazza, for throwing me a large juicy bone re. vol forecasting. Things are starting to look brighter already .



Fox said:


> Not the 3 out of 12 that I had expected.



Correction to my previous post ... I meant "4 out of 12".


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## mazzatelli (5 October 2009)

lol, sorry about the open ended reference
Just wanted to add that its great to see you articulate your endeavours honestly and objectively with great detail, and learning from your experiences.

You've pretty much covered most of the 'gotchas' IMO, so not much extra input here.

Keep up the good work


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## wayneL (5 October 2009)

Fox said:


> *Bungle #5: Fooled By Volatility*




Fox, being a non-mathematician I've wrestled with this problem for quite some time. i.e. extrapolating sigmas into a probability of directional movement in a set time frame, as you do with flies and condors.

But there is a problem at the heart of the way volatility is calculated which makes it unsuitable for this purpose, viz, the annualized standard deviation of logarithmic *daily change* in price.

This is what I wrote in a blog post a while ago - 



> Option volatility takes no account of the trendiness of the underlying instrument however.
> 
> Let say instrument (a) moves 1% up and 1% down alternately for 20 days in a row, but instrument (b) moves up 0.5% every day for twenty days.
> 
> ...




Although the standard practice is for volatility to be annualized (and sometimes extrapolated to "monthized" for we d-neutral traders), in my opinion this is a complete furphy, and a highly dangerous assumption.

This is the reason I abandoned so-called "high probability" condors in favour of  flies and low probability condors and adjust/morph as necessary. 

I used to take some losses on my high prob condors, but so far have not had a loss on the low prob variety (it will come one day I'm sure). Total risk is also much lower in the low-prob variety in the event of a black swan.

I now only use volatility for pricing and largely ignore it for determining probability of price swings over time periods. It is using a ring spanner to hammer in a nail IMO.

Witness low volatility (as measured) trends that can move one helluva a long way in any number of instruments; the grinding upward move that can go 20% or so as you watch statistical volatility sliding the slippery slope to historic lows.

FWIW


----------



## Fox (5 October 2009)

wayneL said:


> I used to take some losses on my high prob condors, but so far have not had a loss on the low prob variety (it will come one day I'm sure). Total risk is also much lower in the low-prob variety in the event of a black swan.



Wayne, I really appreciate your insights into low prob flies/ICs. The "hands on" experience that you are sharing will never make it to option text books and someone like me will have a slim chance of knowing them. Your positive experiences with these strategies gives me confidence that they are viable.

I'm currently half way through Natenberg. His view is biased towards the theoretical ie. unless you identify market discrepancies in option pricing, you will not have a *mathematical "edge"*. That idea does appeal to me, as I like to take comfort that there is a mathematical basis to being profitable in this game, much like card counting is to blackjack.

On the other hand, I also like to believe that option theory has its loopholes. Your take on volatilities is one such example. Comments from Grinder and Sails also indicate this to be the case. They talk about managing the greeks as being their "edge". I would like to prove to myself that this *management "edge"* is real. In my case, only time and practice will tell.

Whether the "edge" is mathematical, management (human) or due to deficiencies in option theory (or perhaps all 3), I'm just glad that there are real players out there, who are able to profit from them. 



wayneL said:


> Witness low volatility (as measured) trends that can move one helluva a long way in any number of instruments; the grinding upward move that can go 20% or so as you watch statistical volatility sliding the slippery slope to historic lows.



Being a non-mathematician myself as well, my humble opinion is that the problem stems from the fact that sigma is derived from *magnitude* of price movements. *Direction *of movements are not factored in. Therefore up,up,up,up vs. up,down,up,down movements are (incorrectly) given equal weight when determining sigma. Much like EWMA is better modelled with appropriate weights, as compared with standard HV calculations. (Thanks Mazza, for pointing that out)


----------



## mazzatelli (6 October 2009)

> But there is a problem at the heart of the way volatility is calculated which makes it unsuitable for this purpose, viz, the annualized standard deviation of logarithmic daily change in price.




As above, daily frequency of close-to-close hv, causes sampling errors [small sample] or irrelevant info incl. [large sample].
Improvements via high frequency data [expensive for retail] or estimates that incl. combos of OHLC e.g. Parkinson, Garman Klass



> Being a non-mathematician myself as well, my humble opinion is that the problem stems from the fact that sigma is derived from magnitude of price movements. Direction of movements are not factored in. Therefore up,up,up,up vs. up,down,up,down movements are (incorrectly) given equal weight when determining sigma




Try profiling price 'behaviour' by quoting price changes in sigma units. E.g. XYZ & ABC stat vol =50%. 
Most price changes [up/down] of XYZ [=/<]2 sigmas. ABC price changes are primarily [=/<] 1 sigma, but monthly has moves > 4 sigma. 

Range plays are > suitable for XYZ than ABC [appears better to be long gamma/vega] despite annualized stat vol of both being 50%. [Independent of other analysis]


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## Grinder (6 October 2009)

Fox said:


> I'm currently half way through Natenberg. His view is biased towards the theoretical ie. unless you identify market discrepancies in option pricing, you will not have a *mathematical "edge"*. That idea does appeal to me, as I like to take comfort that there is a mathematical basis to being profitable in this game, much like card counting is to blackjack.
> 
> On the other hand, I also like to believe that option theory has its loopholes. Your take on volatilities is one such example. Comments from Grinder and Sails also indicate this to be the case. They talk about managing the greeks as being their "edge". I would like to prove to myself that this *management "edge"* is real. In my case, only time and practice will tell.
> 
> Whether the "edge" is mathematical, management (human) or due to deficiencies in option theory (or perhaps all 3), I'm just glad that there are real players out there, who are able to profit from them.




I figured awhile back (after taking some hefty losses) that you need to play to your strengths not your weaknesses if you want to survive, and that the math has to make enough sense to justify your postioning for say positive expectancy or understanding how the greeks represent in your portfolio but should'nt (at least for me) be the basis of all the decision making. I'm sure theres quants (mazza) that can get it done on the math alone, that aint me. So I do what works for me & thats strictly managing my low prob ICs & letting theta grind out the profits.


----------



## Fox (6 October 2009)

mazzatelli said:


> Try profiling price 'behaviour' by quoting price changes in sigma units.



Mazza, Your idea of profiling (see above) lead me to think that comparing 

a. HV calculated using daily gains VS
b. HV calculated using weekly gains 

may lead to similar conclusions. I experimented with real data from CBA and BHP which are now both showing HV of 23%, but are different in nature. The results are are below and they are startling. That's why you're the quant, and I'm not.:bowdown: Brilliant!:thankyou:

```
[FONT="System"]
Underlying          BHP      CBA
Daily(30)            23.0     23.4
Weekly(10)         23.3     30.7
[/FONT]
```

... unless I'm jumping to conclusions too early , in which case, shoot me (compassionately).


----------



## wayneL (6 October 2009)

mazzatelli said:


> As above, daily frequency of close-to-close hv, causes sampling errors [small sample] or irrelevant info incl. [large sample].
> Improvements via high frequency data [expensive for retail] or estimates that incl. combos of OHLC e.g. Parkinson, Garman Klass
> 
> Try profiling price 'behaviour' by quoting price changes in sigma units. E.g. XYZ & ABC stat vol =50%.
> ...




I had to read that three times mazza. 

Once converted into wayneL language, yes - makes perfect sense and something I've actually been trying to quantify in "retail trader style" for some time.

It's given me a couple of ideas for a retail muppet's indicator, thanks.


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## Fox (6 October 2009)

Grinder said:


> letting theta *grind *out the profits.



Ah! now I understand where you user name *Grind*er comes from!


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## mazzatelli (7 October 2009)

Yeh, the math is only to quantify ideas for analysis. Models are like any other tool, you still need market experience & mgmt. That's why I like learning and listening to more experienced traders; Cottle, Wayne, sails, boss etc.



Fox said:


> a. HV calculated using daily gains VS
> b. HV calculated using weekly gains




Although not exact, this is conceptually a variance ratio test of random walk [trend/mean reversion indicator]. 
IMHO it doesn't adequately describe the 'behaviour' of the underlying. You'd like to know the range and frequency of its stdev moves. 

I'd add using different time composites to account for trends. 
E.g. XYZ daily moves [=/<] 2 sigmas - sounds great for range play. But, also assume XYZ often moves [=/<] 2 sigmas for 3 consecutive days, this is a 6 sigma move - killing any IC, lol. 
IOW, profile _x_-day price changes as well.

edit: sorry guys about the writing. I tend to be too verbose or too concise


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## Fox (7 October 2009)

*Postscript to Bungle #5 Fooled by Volatility*

After giving much thought to all the comments from Mazza and Wayne, I think I have traced the source of my mistake. The mistake I made was to equate an *annualised* volatility with the *annual* volatility itself. The former is actually the daily volatility measure expressed in an annualised form. The latter is the volatility measure of annual price movements. They are NOT the same thing and there is grave danger in interchanging both terms. Well, if you have an option position, let me assure you that you will feel your error .

As pointed out in Mazza's last post, the numbers are used to quantify ideas. They do not reveal the complete and true nature of those ideas. 

Let's turn to nature to illustrate my bungle. Join me on a leisurely walk down to Cottlesloe beach and consider a ripple, a wave and the tide. The ripple rides on the wave. The wave rides on the tide. The tide goes up and down each day like clockwork.

I'll pretend to be an oceanographer and measure the volatility of the ripple by recording the height of a ripple. I would say, it is about a centimeter. Next I measure the volatility of the wave and it is about 1 meter. I'm too lazy to use the word "centimeter" because it has 4 syllables, I decide to use the term "meter" instead. So I say that the ripple's volatility is one hundredth of a meter. But being the lazy bugger, "one hundredth of a" is a mouthful. I start calling it a wave equivalent or "wavethised" 1 meter. "1 meter" - that's nice and easy to describe volatility of a ripple.

I get all excited and start reporting my findings to my fellow geeks at the local amateur oceanographer club. Soon, I convert everyone to be lazy buggers and we all agree to refer to ripple volatility measurements in "wavethised" units of X meters.  We all had a jolly good time measuring ripples, waves and tides in "wavethised" units, proudly displaying and interpreting our charts.

Notice that all I measured was the height of the ripple. Being an amateur, I did not know how to quantify the ripple's beauty, its colour, its foaminess, it's roundedness etc. So the ripple has now been diminished to be one dimensional in nature ie. short or tall. Sorry ripple, I have wronged you.

A few years passed and a new member (Baby Fox) joined our amateur oceanographer club. Baby Fox listened with wide eyed wonder about our ripple and wave measurements. A few scientists among our members suggested that we can estimate wave volatility from ripple volatility. Baby Fox was fascinated by this. Besides everyone in the club referred to ripple volatility in meters. Poor Baby Fox got confused but was too embarrassed too ask. So, Baby Fox just assumed that ripple volatility and wave volatility were one and the same thing. 

The official designated club measurer measured ripple volatility to be half a centimeter one day and recorded it as half meter in "wavethised" units. Baby Fox read it to mean a calm day because he interpreted the figures to mean that the wave was only half a meter high. A good day to paddle out to sea in his plastic dinghy, he thought. A ten meter wave came along and the sharks had a tasty feast that day.


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## Fox (7 October 2009)

Profiling using data from post #56. Plot looks similar when sample size increased to 1500.


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## Fox (14 October 2009)

*Bungle #6 Human error*

I attempted to buy an iron butterfly (IB) today  for a $1.14, using Interactive Broker's TWS. This was a credit trade ie. I was to receive $1.14 for this trade. I was careful to preview my order to ensure that it was indeed a credit trade. IB's convention is that if you bought a spread for a credit, the price of the spread is shown as a negative price. I verified that it was -$1.14. I then transmitted the order. So far so good.

I then decided to change my price for a better credit of -$1.16 and wait for a fill. I clicked on the price field and must have hit the backspace key all the way to the left, when I should have stopped at the minus sign. So I entered $1.16 instead of -$1.16 and hit the transmit button. To be honest, I'm still unsure that I actually made this mistake, but the audit trail suggests that I did.

It was an instant fill, much to my surprise. Fear set in. This is really turning into a nightmare. I checked my invoice and to my horror, it was a debit instead of a credit.

I called IB customer support. They contacted the counter party, which I assume is the MM. The counter party refused to accept that a mistake was made when it clearly was the case. I lost my faith in humanity today. The worst in us surfaces when interactions are anonymous.

I have bought and sold IBs a few times and have never made a mistake until now. This is one hard mistake to forgive myself. I also find it hard to believe that the trading platform did not have a reasonableness test built into each order. If dropping my coffee cup onto my keyboard accidentally resulted in $100000 being the order price transmitted, I dread to think what the consequences of that would have been.

*Lessons learnt:*
1. Spread orders are *not bound *by bid and ask prices. If you enter an incorrect price, you are not limited to the bid and ask price. 
2. Human errors will occur. You can only try your best to be as careful as possible.


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## Grinder (14 October 2009)

I know the feeling Fox it, it bites hard. Not giving you any false hope but when something simmilar happened to me i was like a dog with a bone & refused to quit barking, funny enough by my surprise the broker bought into it & finally caved. He ended up wearing half of it for me, thinking I was gunna trade some size with him, changed brokers a week later.


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## wayneL (14 October 2009)

Fox said:


> *Bungle #6 Human error*
> 
> I attempted to buy an iron butterfly (IB) today  for a $1.14, using Interactive Broker's TWS. This was a credit trade ie. I was to receive $1.14 for this trade. I was careful to preview my order to ensure that it was indeed a credit trade. IB's convention is that if you bought a spread for a credit, the price of the spread is shown as a negative price. I verified that it was -$1.14. I then transmitted the order. So far so good.
> 
> ...



Fox,

I had some funny things happen to me with fly orders this month also.

I put it in the "You Idiot" file as a mistake in setting up the order, but still unsure what the hell happened. 

The lessons I learned long ago. 

1/ It's one trade, correct it and move on.

2/ Have a "You Idiot" file. You can laugh at yourself and show it to your grandkids... even put some of it in your book when you become rich and famous. 

3/ Compare it to some of the legendary fat finger trades from insto traders, you'll feel better once you realize that even the pros #### up.

4/ Have a beer an enjoy the day anyway. 

One day the mistake will be in your favour. I once made $30k on a stop I forgot to cancel LOL. It still went in the "You Idiot" file though, it could easily have gone the other way.

Cheers


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## cutz (14 October 2009)

Hi Fox,

It looks like we all make errors, i had a large setback some time ago, buy as an opening trade instead of a sell, choose to let it ride but lady luck coupled with massive negative theta wasn't so kind.

Still make errors, no matter how careful i am it still happens from time to time but now i reverse them straight away, i think errors are part of doing business. 

BTW, those iron flys, i prefer to execute ( well a slight mod to the iron fly, double backspreads ) as short straddles and long strangles, another mazza tip.


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## Fox (15 October 2009)

Thanks for your soothing words, guys. It's good to know that I do not have a monopoly on "You Idiot" mistakes . It is approaching 24 hours since the unfortunate incident and time is starting to heal, but very slowly though. 

Logically, I know that I should eventually offset this temporary loss if I were to survive this game. If this is not the case, then I should not even be options trading at all. 

Emotionally, it feels as if I'm playing Manchester United with Man U given a 10-0 head start.

Someone once wrote that a man who enjoys exciting bedroom antics with his wife is called a happily married man. A man who does not is called a philosopher. I think it's time to put my philosopher hat on today. 

Wearing this hat, I think that the mishap is actually a positive indication.  For me to make this error, it must indicate some complacency on my part. Complacency can only come about if I have lost fear. To lose fear, I must have gained confidence. 

My record on low prob flies so far has been 2 losers, 3 winners. The first 2 trades were the losers and these happened when I was learning most. The last 3 trades I executed have been winners and perhaps I must have been getting complacent.

The best analogy for trading with IB is perhaps that of owning a gun. It is essential for me to hunt for food. It can also help me shoot myself. 

I recall my ancient days with ETRADE where a human operator vetted each spread order and kept stopping me from making trades that were logical to me. I was pretty frustrated when that happened. I found IB and I felt free to trade as I like. Freedom comes at a cost. That cost is vigilance and self restraint.

The whole incident could just be a computer glitch on IB's part and I'm rambling on for no reason. I still maintain that possibility. As per the gun analogy, who is responsible if the gun misfires? Or perhaps the correct question is if a misfiring gun is better than no gun?


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## cutz (15 October 2009)

Hi Fox,

If you don't mind me asking what was the result, it's always been a bit of a mystery to me, what if a negative indicated spread was bought for positive pricing.

Have you got a breakdown of all the legs and how they compare with the settlement prices?


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## mazzatelli (15 October 2009)

I once forgot that Aus date formats[dd-mm-yy] differ to US [mm-dd-yy].
Shorted vol on a stock thinking earnings was later, when in fact it was that very day 
Deltas accumulated in after market trading...I literally sat there and laughed [what else could I do?] 

Fox, its all part of the gig. Have this :alcohol: and/or one of these:bong: :


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## Grinder (15 October 2009)

Happening more often now that Im waking up in the middle of night, trading half asleep while the cat does'nt stop hassling me to let it out. Fortunately my broker platform prevents wrong orders (BTO already open orders, STC when I should be buying)  




mazzatelli said:


> Fox, its all part of the gig. Have this :alcohol: and/or one of these:bong: :




Lol


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## Fox (15 October 2009)

cutz said:


> If you don't mind me asking what was the result, it's always been a bit of a mystery to me, what if a negative indicated spread was bought for positive pricing.
> 
> Have you got a breakdown of all the legs and how they compare with the settlement prices?



The red ellipse is the overpriced OTM put option sold to me. It should be a few cents or so if this was executed as a credit spread. By entering a debit spread, the additional cost is passed to overpriced OTM put of $2.355. Multiply that by 2 Aussie contracts ... ouch! 

The fact that +$1.165 exceeded the ask price of slightly less that -$1 did not result in -$1 being the settlement price. The bid and ask price of a spread is just an estimate of the price of the spread and NOT the actual bid and ask price. Novices beware! Just because I entered a limit order of +1.165 which exceeded the -$1 ask price did not result in the ask price being settled. It was my limit price that was settled. 

My natural instincts tell me that if I intend to purchase an item and I am willing to pay more than the asking price of the seller, the seller's price is the settlement price. My experience makes a mockery of the term *limit order* and *bid and ask* prices being displayed in TWS for spreads.


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## Fox (15 October 2009)

Grinder said:


> Fortunately my broker platform prevents wrong orders



Does your broker do Aussie options? Or is US options only?


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## mazzatelli (15 October 2009)

That is one small butterfly!!! - personally would require the fly to have a minimum 5pt differential. Out of curiosity [no need to answer] is this spread still active?


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## Grinder (15 October 2009)

Fox said:


> Does your broker do Aussie options? Or is US options only?




It's OX. Just the US now.  Have an account with IB but don't use, don't like the cancellation fee or lack of confirmation screen amoung other things. Miss the real low commish fees from IB, but it's all a trade off.


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## mazzatelli (15 October 2009)

There is a way around the cancellation fee for IB. Instead of canceling the order- substitute a ridiculous price. E.g. buying a calendar, decide to scrap it, place the order as $0.01 [assuming GTC]


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## cutz (15 October 2009)

Thanks for sharing Fox,

Yeah the indicative spread price is the resultant of the legs showing spreads, some of those legs may only be showing one side so i can sort of see how something like that could happen.
I suspect it would have been the case with the 27 put, a botched trade on the no show side would have been a free for all.


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## Fox (15 October 2009)

Grinder said:


> the cancellation fee



I did not realise that there was a cancellation fee. I never had any cancellation fee charged to me for Oz options. So this is just of US options I presume? Also, strange that this fee is charged by IB and not by OX. How much is the cancellation fee?


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## Fox (15 October 2009)

mazzatelli said:


> is this spread still active?



Yes.



mazzatelli said:


> require the fly to have a minimum 5pt differential.



By "5 pt differential", do you mean something like 25/30/35? I used 27/29/31 because the profit zone (a.k.a goal posts) was more than +/- 1 sigma (weekly period). I'm still trying and learning as I go along ie. trial and error. Any comments/suggestions/hints/advice are more than welcome, Mazz.


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## Grinder (16 October 2009)

Fox said:


> I did not realise that there was a cancellation fee. I never had any cancellation fee charged to me for Oz options. So this is just of US options I presume? Also, strange that this fee is charged by IB and not by OX. How much is the cancellation fee?




Can't quite remmeber, believe it's stated on their website somewhere. Theres alot of things one broker will do and another won't. Don't bother calling them to ask unless your after some BS line (if you an get a hold of em that is)




mazzatelli said:


> There is a way around the cancellation fee for IB. Instead of canceling the order- substitute a ridiculous price. E.g. buying a calendar, decide to scrap it, place the order as $0.01 [assuming GTC]




Your an ideas man


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## mazzatelli (16 October 2009)

Fox said:


> By "5 pt differential", do you mean something like 25/30/35? I used 27/29/31 because the profit zone (a.k.a goal posts) was more than +/- 1 sigma (weekly period).




Yes. 
My bias is due to inefficiency of dynamic hedging such a small profit zone + if it is a vol bet, I'd prefer more exposure of atm vols. But my trading/hedging style differs to yours.

Apologies, as you were


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## wayneL (16 October 2009)

mazzatelli said:


> Yes.
> My bias is due to inefficiency of dynamic hedging such a small profit zone + if it is a vol bet, I'd prefer more exposure of atm vols.




By preference also. FWIW


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## Fox (16 October 2009)

mazzatelli said:


> ... to inefficiency of dynamic hedging such a small profit zone.



Thanks Mazza/Wayne. Your views noted and much appreciated.

I was focusing too much on the "low prob" aspect of the fly and losing sight of the inefficiencies (I presume you mean contest risk, fees, etc). I'll experiment with a bigger profit zone in my next attempt. 

Girls are wrong when that say size does not matter, especially when used efficiently . No more fly envy from now onwards. Mine will be as big as Mazza and Wayne's :casanova:.


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## Fox (16 October 2009)

I tried modelling the 25/30/35 and compared it with a 22/30/32 when the spot is at 30 with 6 weeks to expiry. I will refer to the 25/30/35 as Wide Fly (WF) and the 22/30/32 as the Narrow Fly (NF).

I can see that adjusting WF for delta neutrality will be easier than NF. To my inexperienced eyes, the gains in the profit zone appears incremental, whereas the risk to reward (R/R) ratio of WF is not as good as the NF. What other benefits of WF am I not seeing?

If the WF and NF were initiated as longer term spreads, say 6 months to expiry, the gains in WF's profit zone would of course be much larger. The R/R differences differences between WF and NF will be reduced. Could that be the point I am missing? ie. that WFs with longer time to expiry are the way to go?


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## mazzatelli (16 October 2009)

It's been a long time since I have looked at Oz options, but with only ~ $1.40 juice in the 29 WOW Straddle - I personally wouldn't hold the fly for a bet on distribution. 

I'd imagine it would be like GE [pre GFC, lol] 

In terms of time to expiry 40<_x_<12 days. Otherwise too much sensitivity to vegas/gammas than desired, IMO


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## cutz (17 October 2009)

Hi Mazza,

I guess what you're saying is flys aren't ideal in the current low IV situation, i'm sort of coming across the same thing on index series.

What are you're thoughts on trading the options on stocks you know nothing about, for instance would you just be comfortable knowing the price history of the underlying and option stats ?


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## Fox (17 October 2009)

cutz said:


> I guess what you're saying is flys aren't ideal in the current low IV situation ...



Cutz, I think you may have answered my question in my earlier post. I tweaked the IV up from 17% to 40%, and WF (blue) looks much more attractive. Thanks Cutz.


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## cutz (17 October 2009)

Hi Fox,

That fly you have on is short volatility, these days the opposite trade looks more attractive, and you can even put the natural on for credit.


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## mazzatelli (17 October 2009)

cutz said:


> What are you're thoughts on trading the options on stocks you know nothing about, for instance would you just be comfortable knowing the price history of the underlying and option stats ?




Yes; historical price + iv [adj] to model vol time series. My 'edge' is in vol forecasting.
In essence - quantitative understanding of stock rather than fundamentals, though I do have sector analysis and custom indices for relative strength.
Earnings, FDA approvals etc obviously handled differently


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## sails (18 October 2009)

Fox said:


> *Bungle #6 Human error*
> 
> I attempted to buy an iron butterfly (IB) today  for a $1.14, using Interactive Broker's TWS. This was a credit trade ie. I was to receive $1.14 for this trade. I was careful to preview my order to ensure that it was indeed a credit trade. IB's convention is that if you bought a spread for a credit, the price of the spread is shown as a negative price. I verified that it was -$1.14. I then transmitted the order. So far so good.
> 
> ...




Hey Fox - it is recorded somewhere here in the archives of ASF where I was also bitten by IB's negative pricing on spreads.  I lost 3K in the blink of an eye.  I had not previously had any experience with negative pricing and found it quite confusing to say the least.  Had a similar response from IB as you did.

At the time, I went through all the ASX documentation and found buried somewhere in their site that online brokers to the Oz market are required to ensure adequate filters for online trading.  I believe you should at worst pay no more than the ask on any leg and get no less than the bid on any leg.  I felt that, if there had been adequate online filters, there would have been an error message of some sort giving the opportunity to cancel the order.

The ASX site do have a complaint form.  I filled one out on the basis of the lack of adequate filters, but in the end decided not to proceed at that time.  My reasoning was that IB would probably get upset and wouldn't want me as a customer - leaving me stuck with Oz brokers high fees.  At the time, I was trading quite heavily and would have lost a similar amount in fees alone over a period of time. 

I also thought IB had fixed this negative pricing in spreads.  I remember sending an email to their Oz office and it all appeared to be fixed at the time.  Option trading is difficult enough without having to deal with negative pricing when positive pricing with the appropriate buy or sell attached to the order does the job and removes that element of confusion.

I think I still have the ASX form I filled out somewhere if you are interested in how I had planned to go about the complaint.  I'm not one to blame others for my mistakes, but don't like it when the mistake has happened due to someone else's slackness. 

One of my initial reasons for considering sending in a complaint to the ASX was to hopefully help prevent others from getting burnt in the same eat - so now I am regretting not following through as it may have forced IB to improve their filters and spared you (and maybe many others) the pain.

I also have my suspicions that this is something that is not a worldwide thing with IB - possibly just in the Oz market and maybe other smaller countries.  I have never heard of anyone using IB for US trading complain of this negative pricing thing. 

If anyone is using IB to trade US options - have you ever had spreads show up as negative amounts?  eg you want to sell a spread, but the order shows up as a buy with a negative price?

Anyway, sorry for the late reply - didn't log into ASF for a few days!


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## cutz (18 October 2009)

Hi Sails,

I don't trade US options because of the hours but buy for credit spreads are quoted as negative prices on the euro exchanges.


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## sails (18 October 2009)

Thanks Cutz - so it's also on the euro exchanges.  I used to regularly read the option forums at ET and never heard complaints about IB dishing up negative pricing for US option spreads.


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## Fox (18 October 2009)

sails said:


> I believe you should at worst pay no more than the ask on any leg and get no less than the bid on any leg.



That's my view as well. When I entered the incorrect price, the ask price was around -$1. I would have thought it fairer that -$1 instead of +$1.16 be the price I paid for the spread.

You are quite right about the lack of choices of brokers for oz options. I'm currently only playing for small stakes ie. single contracts. Although I lost a bundle in this bungle, I would have lost the same amount in the last 3 months in fees alone had I stuck with etrade and commsec. Hence, my analogy of owning a gun that misfires being better than not owing a gun at all. 



sails said:


> .. didn't log into ASF for a few days!



You have been missed in this forum, I'm sure. Good to have you back.


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## mazzatelli (18 October 2009)

sails said:


> If anyone is using IB to trade US options - have you ever had spreads show up as negative amounts?  eg you want to sell a spread, but the order shows up as a buy with a negative price?




It happens for some custom spreads e.g. Iron Flies, ratio flies


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## sails (18 October 2009)

Fox said:


> That's my view as well. When I entered the incorrect price, the ask price was around -$1. I would have thought it fairer that -$1 instead of +$1.16 be the price I paid for the spread.




But why they have to turn prices upside down when it is totally unnecessary in the first place is totally beyond me.  

I have occasionally used negative pricing (since I learned about it the hard way!) - but it has been for the reason of placing an order for a cheap spread and keep it far enough away from the market while observing what's going on in market depth before getting serious about getting it filled. 



> You are quite right about the lack of choices of brokers for oz options. I'm currently only playing for small stakes ie. single contracts. Although I lost a bundle in this bungle, I would have lost the same amount in the last 3 months in fees alone had I stuck with etrade and commsec. Hence, my analogy of owning a gun that misfires being better than not owing a gun at all.




As long as it doesn't misfire too often and too fatally!




> You have been missed in this forum, I'm sure. Good to have you back.




thanks - but it's good there are now so many others to offer help and share their experience in the options threads here at ASF!  
As others know, I have a daughter that has been unwell for some time and she is now a single mum with two girls.  So most of my trading has been put on hold to help them through this rough time.  And the good news is we are seeing steady improvement - and that makes the effort so worthwhile!  So, there will be times I disappear - hopefully no more than a few days at this stage anyway!


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## sails (18 October 2009)

mazzatelli said:


> It happens for some custom spreads e.g. Iron Flies, ratio flies




Do you know why it's done, Mazza?  
Is there any purpose to it at all except for hoping to catch the unwary and relieve them of their account funds? need a sarcastic smiley here!


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## wayneL (18 October 2009)

sails said:


> And the good news is we are seeing steady improvement - and that makes the effort so worthwhile!  So, there will be times I disappear - hopefully no more than a few days at this stage anyway!




That's good to hear M.  Much more important than any stinking option.

Best wishes for continued improvement.


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## mazzatelli (19 October 2009)

sails said:


> Do you know why it's done, Mazza?
> Is there any purpose to it at all except for hoping to catch the unwary and relieve them of their account funds? need a sarcastic smiley here!




I've no idea M, but it is definitely annoying. 
If only they could replicate TOS execution platform, they would be perfect 
btw, great to hear the family situation is improving. May it continue!!!


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## cutz (23 October 2009)

Hi Fox,

With your iron fly, set it up as a sell/buy/buy/sell and you will get normal pricing (without the negative), works a treat.


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## Fox (23 October 2009)

cutz said:


> set it up as a sell/buy/buy/sell and you will get normal pricing (without the negative), works a treat.



Duh! Why didn't I think of that? That's going to help all my future IB trades. Thanks Cutz. That is a very elegant solution to a horrible problem. A good example of thinking outside the box.

All novices, listen up. This tip from Cutz will save you a lot of heart ache.


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## sails (24 October 2009)

cutz said:


> Hi Fox,
> 
> With your iron fly, set it up as a sell/buy/buy/sell and you will get normal pricing (without the negative), works a treat.




Hi Cutz - have you found this works in real time?  I thought I did something like that when I tried to exit my fateful calendar spread with IB - and found I had paid a debit instead of receiving a credit.

At the time, the description that TWS generated didn't make sense, so make sure it's all OK before clicking OK - which is also the point of no return. 

EDIT:  Have found the thread where this was discussed - and this is the initial post where I posted a screen shot screen shot: https://www.aussiestockforums.com/forums/showthread.php?p=206523#post206523  and another: https://www.aussiestockforums.com/forums/showthread.php?p=206855#post206855

Hopefully, my mistake can be used to help prevent others doing the same thing!


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## cutz (24 October 2009)

Hi Sails,

Yep that iron fly i was describing i've used in real time so selling the credit spread works the way that's expected and you end up with a short position.

It also worked when i was building a put backspread on an equity position, initially i entered the legs as buy more/sell less, got negative pricing then deleted that combo, set it up as sell more/buy less and it worked beautifully.


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## sails (24 October 2009)

cutz said:


> Hi Sails,
> 
> Yep that iron fly i was describing i've used in real time so selling the credit spread works the way that's expected and you end up with a short position.
> 
> It also worked when i was building a put backspread on an equity position, initially i entered the legs as buy more/sell less, got negative pricing then deleted that combo, set it up as sell more/buy less and it worked beautifully.




Thanks Cutz - that's good to know.  I am a bit paranoid when selling spreads with IB as that's where it can go so wrong.  Buying poses no problems as no MM is going to let you buy something for a negative price - but they will let you sell something for a debit.



wayneL said:


> That's good to hear M.  Much more important than any stinking option.
> 
> Best wishes for continued improvement.






mazzatelli said:


> I've no idea M, but it is definitely annoying.
> If only they could replicate TOS execution platform, they would be perfect
> btw, great to hear the family situation is improving. May it continue!!!




Thanks for the encouragement, guys!  Yeah, I miss the option trading, but in the bigger scheme of things, we seem to be making a difference.  Hasn't been smooth sailing this week, but when looking back to what we faced 12 months ago, the improvement is very clear.


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## Fox (24 October 2009)

sails said:


> Do you know why it's done, Mazza?



Could this be a reason? 

Timberhill Australia Pty Limited - Broker code AU940 is an ASX approved MM.
Timberhill Australia Pty Limited is also known as Interactive Brokers.
MMs handle spread orders.
Fat finger errors of debit instead of credit spreads due to negative pricing are snapped up by the MM.
If the platform provider (ie. broker) and the MM are one and the same, then logically fat finger errors would not be discouraged.


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## sails (25 October 2009)

Fox said:


> Could this be a reason?
> 
> Timberhill Australia Pty Limited - Broker code AU940 is an ASX approved MM.
> Timberhill Australia Pty Limited is also known as Interactive Brokers.
> ...




lol - my sentiments exactly... 
Not saying it is, but it certainly begs the question...


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## Fox (28 October 2009)

*Bungle #7: Obsession with expiry*

Before I found ASF, the end game to me was always last Thursday of the month ie. expiry date. There were two reasons for this. 

The first was the indoctrination from introductory options trading books which equate the value of a strategy with the P&L profile at expiry. I suspect that books do that because it is easier to describe something static, as opposed to something that is dynamic. P&L profiles at expiry is as static as they come. No other variables like time and volatility to consider. Just straight lines with huge profits to boot.

The second reason for being obsessive with expiry is due to the high fees charged by Oz brokers. The idea of forking out huge sums to close your position early just did not seem justified.

Over time, that just became gospel to me. I recall posting a question in ASF as to why professional traders exit their butterfly so early, while it appears as if there is so much potential profit left to harvest. The seasoned ASF members were too polite to point out the folly (euphemism for stupidity) of my thinking. Instead gentle hints like "risk/reward ratio is no longer attractive" were floated nonchalantly.

Too nonchalantly. It slipped over my head. I read better books to search for answers. "Risk/reward ratio" and "would you put on this trade today if you did not already have this position" was bandied about in other forum posts. At long last, after weeks of mulling over this, the lights FINALLY came on!

Aaahhhhhh! Asodaska! There is no end game. Every instant in our lives is merely a closing of our current position and reopening of that same position in the next instant. That's what the guys meant when they talk about "risk/reward ratio". I should be constantly evaluating my risk/reward ratio at every instant and determine if it is still worth my while to hold that position.    

Then, a bigger realisation hit me. This philosophy applies to all aspects of our lives. It applies equally to long term blue chip portfolios. Perhaps even our associations with shady characters. What about our flirtations with risky but pleasurable  extra-curricular activities? At some point, the R/R just doesn't cut it anymore.

Now I know why the butterfly is exited early. Simply put, the risk outweighs the reward as expiry approaches. But like a fluorescent lamp that draws moths in a hypnotic flight to their death, novices are drawn to those fat profits of static P&L diagrams, much to their own detriment.

*Lessons learnt:*
1. Reassess you risk/reward ratio on a continuous basis.
2. Switch to a better risk/reward profile when prudent to do so.
3. P&L profiles only tell half the truth. Risk is not apparent in those diagrams.


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## Fox (10 November 2009)

*Bungle #8: Margins*

Boy, the lessons keep coming, hard and fast. I just got whacked today by a forced liquidation. I did not even see it coming.

I'm with Interactive Brokers and have what they call a Reg-T Margin account. How margins are calculated are a bit of a mystery me. To avoid any margin problems, all I have done was to ensure that I have lots of cash and ensure that the initial and maintenance margin were well below the cash I had. Until today's unfortunate incident, I had not experienced any problems whatsoever with margins.

I called IB customer support to figure out what happened. I had lots of cash, and was puzzled why I had problems with margins. Their reply was that my *Special Memorandum Account* (SMA) fell below zero. Huh? What the hell is an SMA? 

I could not understand the customer support officer's explanation. She said that there were two methods for calculating margins. One was based on the ASX (during the day) and another was based on the US Reg-T Margin requirements (for overnight positions). I was told that the US Reg-T Margins were higher that the ASX margins and that could have triggered the margin call. 

I read up how US Reg-T Margins were calculated from IB's website. A computer algorithm works out your margins depending on your positions/strategies. I still can't figure out how they calculate your margin if you have some sort of hybrid strategy such as a BWB etc.

Anyhow, I suspect I know the problem now. Since I was essentially writing credit spreads, my cash and initial/maintenance margins my appear sound. But a parameter called *RegT Margin* shown in my *Accounts *page, was large. It was larger than my cash amount. I suspect RegTMargin is a better description of your overall margin obligations. 

But I was still baffled as to what SMA meant. Reading the help docos and googling IB did not help. I found bits and pieces of info on SMA, but I just don't understand what it is and how it is determined. Anyone able to shed some light on *SMA* and *RegT Margin*?

Bottom line is that 1 short call and 1 short put was forcibly closed at the MM's ask price . I could not reinstate those two positions because of margin requirements. I other words, I locked in a loss and was forced to close my positions at the worst possible price. That really sucks. 

*Lessons learnt*
1. Just because you have lots of cash does not mean that a margin call is not looming.
2. Always check you special memorandum account and make sure that it is above zero.
3. Credit spreads may appear to be great, but margins lurk quietly and dangerously in the background.


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## cutz (10 November 2009)

Hi Fox,

Suggest printing out a yesterdays margin report to determine what went wrong but for oz equity options the margin for one 12/10 put credit spread is $2000.


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## Fox (10 November 2009)

cutz said:


> Suggest printing out a yesterdays margin report to determine what went wrong but for oz equity options the margin for one 12/10 put credit spread is $2000.



Good idea, Cutz. I printed out the Margin Report and true enough, the SMA was below zero ie. negative. This accounts for the forced liquidation to be triggered.

The only reason I can see for the SMA to go negative is due to the *Reg T Margin Requirement* jumping overnight by 50%. I have queried IB but not got a response yet. 

According to IB's web page, "US Reg T Margin requirements are also applied at the end of each trading day". This means that while ASX margins are low, the US Reg T Margins being much higher, will be determine your margin obligation.

In my case, the US Reg T Margin requirements jumped from 22K to 34K overnight without me taking on additional positions. Something does not smell right and it is making me very nervous.


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## Fox (11 November 2009)

Just a quick update. IB did reply to my query but did not explain why the Reg T margin jumped overnight by 50%. 

What I did get from their reply was that Reg T margins applied to me because of my XJO options. This explains why I did not have problems with Reg T margins before, as I was trading equity options only then.

The important thing to take note is that if you intend to trade XJO options, then the Reg T margin applies and it is much, much, much larger than ASX margins. And by the looks of it, Reg T margins fluctuate *wildly *as well. So, you need to really cash up to play XJO .

My records showed that the only change in my XJO positions was increasing the distance between the sold and bought strike of my bull put by 150 points. I can't believe that such an action would increase the margin by 50%!


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## Fox (18 November 2009)

Fox said:


> My records showed that the only change in my XJO positions was increasing the distance between the sold and bought strike of my bull put by 150 points. I can't believe that such an action would increase the margin by 50%!




I have finally solved my RegT margin puzzle. This is a real gotcha for newbies. Take the case of RegT margins for IB vs a BWIB. 

An IB being "balanced" (_ie. the call vertical and put vertical being equal in risk_), the RegT margin is the difference in the sold and bought strikes of the vertical. Take the example of a 10/20/30 IB. The call vertical's margin is 10 and the put vertical's margin is also 10. But when combined as an IB, the total Reg T margin is only 10 (NOT 20).

A BWIB being "unbalanced" has the RegT margin being the sum of margins of both verticals. For example, a 10/25/30 BWIB will have a call vertical Reg T margin of 15, and a put vertical margin of 5. The BWIB as a whole will incur a RegT margin of 15+5=20!

By morphing the above IB to a BWIB, the Reg T margin jumped from 10 to 20 . That was precisely what happened to me. I adjusted my IB to a BWIB without realising that the RegT balloons for "unbalanced" spreads. Scary stuff. 

It has implications for your rate of return as trading in "unbalanced" spreads will require significantly larger margins. A fact to pay large attention to!


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