# Delta Neutral Trading - Condors etc.



## wayneL (22 January 2009)

There have been a couple of questions on delta neutral trading both on the forum and via PM; I'd promised to start a thread, but have been slack thus far, so here we go.

Feel free to ask questions as we go along.

But first we need to understand a couple of Greeks, starting with "delta" itself. 

The short version:







> The amount an option's price will change for a corresponding one-point change in the price of the underlying security.



To explain it further, we need to understand that all trading instruments have delta. Delta is expressed as a fraction of 1 or -1 (Except if discussing "position delta" which we'll go into in a minute), therefore any derivative's rate of change is that fraction of change compared to the long underlying.

So if we're talking stock and stock options, we know that the delta of long stock is *1*. Another way of looking at it is that for every dollar the stock goes up, we make one dollar... easy.

Therefore if we look at short stock; for every dollar the stock goes up, we will lose one dollar, so short stock has a delta of -1.

Options, in the vast majority of cases have a delta of some fraction of 1 or -1.

An ATM long call has a delta of approximately 0.5, so if the underlying stock goes up $1.00, then theoretically the option will go up by $0.50. Similarly, an ATM long put has a delta of approximately -0.5 and will lose $0.50 for every dollar the underlying rises.

When you write (short sell) options, the delta is reversed, just like if you short sell a stock; short calls have -delta and short puts have +delta.

Position delta (sometimes referred to as delta*s*) is the sum of all the individual deltas in a position.

So if you own 100 shares in a stock, your position delta is 100. Or it can be stated that you have 100 deltas.

If you own one ATM call contract (presuming a contract size of 100 options), your position delta is ~50, or 50 deltas.

to be continued.


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## wayneL (22 January 2009)

So onto "Delta Neutral".

Delta neutral is simply a term to denote any position where your position delta is zero, though in common usage, it refers to a few select strategies which we will get into soon.

But just for the exercise, hear are a couple of delta neutral positions to help understand this concept before we go onto the next important Greek.

1/ Buy 100 XYZ stock and sell XYZ CFDs. We add the deltas of the two positions together, i.e. 100 + -100 = 0.  Voila, delta neutral.

2/ Buy 100 XYZ stock, sell 1 XYZ ATM call contract and buy 1 XYZ ATM put contract, i.e. 100 + -50 + -50 = 0. (this position is called a conversion)

Barring any possible arbitrage profits, the above two positions have zero delta and have no possibility of profit or loss, no matter what the stock does, because the deltas all cancel each other out.

So what would possess someone to go delta neutral?

Enter - GAMMA.....


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## wayneL (22 January 2009)

One of the things that separates the pricing of options as opposed to CFDs and other derivatives is that delta <> 1 or -1.

In fact option delta can vary significantly depending on where the striking price is in relation to the underlying price. As mentioned, a long ATM call option's delta is about 0.5, but a very very deep ITM call option can have a delta of 1 or very close to it. Likewise a very far OTM call option can have a delta of 0 or very close to it. Delta varies at all points in between.

The rate at which delta changes in response to changes in the price of the underlying is called Gamma. Gamma is expressed as the amount that delta changes per 1 point move in the underlying.

For example: Say we have a long call option whose delta is 0.5 and the stock moves up $1 and we now find that the delta is now 0.6. The gamma of that option is 0.1.

As all options have a theoretical gamma figure, we can calculate the change of delta for any position we have. In total this is called "position gamma". The position gamma of 1 contact of 100 options in the above example is 100 x 0.1 = 10. i.e the position delta of that one call contract will increase from 50 to 60 if the underlying moves up one dollar.


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## wayneL (23 January 2009)

A couple of things I should add about gamma:

1/ You can only acquire gamma by acquiring an option position. Stocks, CFDs, Futures, Bonds etc do not have gamma.

2/ Gamma can also be positive or negative. All long options have positive gamma, whereas all short options have negative gamma.

Example

Let say we have one trader with an ATM call option with gamma as per the example in the above post. The delta of the option will be about +0.5 and a positive gamma of +0.1. Therefore as per the example, the delta of the option will rise to 0.6 if the underlying stock goes up $1.

But another trader has a short ATM put option, and like the long call option above, it also has a delta of +0.5. However the gamma is negative at -0.1. What this means is that the delta of the put option decreases to 0.4.

Sorry this is all so long winded, but it is vital in understanding delta neutral strategies.


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## wayneL (23 January 2009)

So how do we profit from being delta neutral

Delta neutral strategies can be either long gamma (+gamma) or short gamma (-gamma).

In long gamma strategies it is the gamma that delivers the profit, by manufacturing deltas. The most common long gamma, delta neutral position is the long straddle. That is, long an ATM call and long an ATM put.

The atm long call has a delta of about +0.5, and the atm long put has a delta of about -0.5. We add the delta together to get the delta of the position: 0.5 + -0.5 = 0. So these two options cancel each other out.

However (and using the example above where gamma is 0.1) as the underlying moves, the delta of these options will change. 

Lets say the underlying goes up one dollar. The delta of the call will become 0.6 and the delta of the put will become -0.4 as the gamma add o.1 to each delta.

So now the strategy has some delta, which has been manufactured by the gamma.  0.6 + -0.4 = 0.2

As the share value increases this change in overall delta accelerates the profit as the share moves away from the striking price, eventually, if the share goes far enough, to 1.0 as the long call's delta will increase from 0.5 to 1.0 and the put's delta increases from -.5 to 0 

Likewise, if the share goes down one dollar the delta of the call will become 0.4 and the delta of the put will become -0.6.

So now the strategy has again some delta, negative this time, which has been manufactured by the gamma.  0.4 + -0.6 = -0.2

We want negative gamma if the stock is moving down and it will become -1.0 if the stock moves down far enough.

So in the long straddle's case, it is a bet each way on stock prices.

What's the catch?

Next Greek - Theta


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## sails (23 January 2009)

Good stuff, Wayne.  It takes a fair bit of time to write such detailed posts!

For those whose head is spinning - I suggest breaking it down and digesting small bits at a time.  I well remember how my head hurt when reading options theory in the beginning.  It's pretty much learning another languague and time, effort and exposure seems to be the only way to master it.

I initially used post-it notes on my monitor and found it a helpful reference when reading options theory eg.

+ delta:  expect market to rise
- delta:  expect market to fall

+ gamma:  expect market to move in direction of long strike
- gamma:  expect market to stay away from the short strike

+ vega:  expect IV to rise
- vega:  expect IV to fall 

etc, etc...


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## Grinder (23 January 2009)

You it explain it well Wayne, it's tough simplfying it so keep up the good work


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## cutz (23 January 2009)

G’Day Everyone.

Wayne on one his posts mentioned that one method of defending a short position that’s gone wrong would be to introduce some opposite delta in the form of buying/selling the underlying, effectively neutralizing delta (or close to neutralizing). At what stage should this be implemented?, i.e when the underlying hits your short contract strike or would you do this as the underlying approaches your strike, say 2 strikes out on a $30 contract?

I’m interested to hear from traders that use this form of defence on shorts, ATM all I use on naked positions that have gone bad is diagonal rolling, normally this works for me but I got caught on the hop recently with an early assignment.


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## wayneL (23 January 2009)

Thanks peeps,

If anything is not clear or causes a , please jump inand ask for clarification.



cutz said:


> G’Day Everyone.
> 
> Wayne on one his posts mentioned that one method of defending a short position that’s gone wrong would be to introduce some opposite delta in the form of buying/selling the underlying, effectively neutralizing delta (or close to neutralizing). At what stage should this be implemented?, i.e when the underlying hits your short contract strike or would you do this as the underlying approaches your strike, say 2 strikes out on a $30 contract?
> 
> I’m interested to hear from traders that use this form of defence on shorts, ATM all I use on naked positions that have gone bad is diagonal rolling, normally this works for me but I got caught on the hop recently with an early assignment.




That's such an important question, but if I can answer that one later, after we talk about short gamma strategies, ut would make more sense in the context of the thread. 

We'll get there.


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## Grinder (23 January 2009)

cutz said:


> G’Day Everyone.
> 
> Wayne on one his posts mentioned that one method of defending a short position that’s gone wrong would be to introduce some opposite delta in the form of buying/selling the underlying, effectively neutralizing delta (or close to neutralizing). At what stage should this be implemented?, i.e when the underlying hits your short contract strike or would you do this as the underlying approaches your strike, say 2 strikes out on a $30 contract?
> 
> I’m interested to hear from traders that use this form of defence on shorts, ATM all I use on naked positions that have gone bad is diagonal rolling, normally this works for me but I got caught on the hop recently with an early assignment.




Dont pick up the underlying, depending on how far out I am & in what month I might start to defend by selling a spread to create a condor or if I like the way the greeks are set up a double diagonal of sorts. Difficult to say, different strategies for different set ups.


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## wayneL (23 January 2009)

Just a quick point going back to "position delta". When you are in a delta neutral position, or one that started off neutral, think of position delta as "exposure" and analogous to holding that number of shares. If your position delta is +200, it is the same exposure as being long 200 shares of the underlying; -50 is like being short 50 shares.

This may be wanted or unwanted, depending on what you're trying to do, but always know this number.

Also think of it as your "hedge" ratio. In other words, to get back to delta neutral, this is the number of shares you need to trade to acquire the opposite deltas.

If you've got 30 deltas, you need to short 30 shares to acquire the -30 deltas to get back to 0, if that's what you need to do (depending on the strategy), or the equivalent deltas via options (long puts or short calls).


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## wayneL (23 January 2009)

wayneL said:


> So in the long straddle's case, it is a bet each way on stock prices.
> 
> What's the catch?
> 
> Next Greek - Theta




Well anybody who has ever traded a straddle will know what the catch is; it's time decay.

With the straddle, because we have two long options per straddle, we get a double dose of it.

Theta measures the rate of time decay. Often "theta" is used in place of time decay, I'm guilty of this, but it's wrong, theta measures the rate of it.

I didn't want this to end up a treatise on greeks, so brushing over these really, just picking out the important bits as far as delta neutral is concerned. For a bit more discussion, refer to by blog post here: http://sigmaoptions.blogspot.com/2008/05/time-time-decay.html (really must develop that a bit more)

So if an option has a theta of 0.03, all other things being it will decay by three cents for that day. That means position theta will be $30 per contract of one hundred options and $60 per straddle.

So our straddle must manufacture deltas faster than theta to be profitable. Theta increases when at the money as time goes by.

So with long gamma strategies such as long straddles, we want a move... somewhere.... NOW .... FAST!

There is one further trap with long straddles and that is volatility crush... vega risk. I won't go too much into that now but here is a blog post on one such situation. - http://sigmaoptions.blogspot.com/2006/12/nike-straddle-just-do-it.html


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## wayneL (24 January 2009)

We can also trade delta neutral strategies with gamma on the short side (-gamma), meaning that we will be writing options instead of buying them.

This is what the vast majority of delta neutral traders trade for a number of reasons.

Look at the long straddle from the previous post. The simplest short gamma delta neutral strategy (and maybe the least traded) is the short straddle. Instead of buying ATM puts and calls, we sell them instead.

With the long straddle, I said we need the underlying to go somewhere NOW and FAST. But the reality is that this isn't what usually happens and long term and systematic straddle buying is a loser... heavily. Most of the time stocks go up a little bit, retrace a little bit, go up a little bit again, then go down, etc, frustrating the straddle buyers into bankruptcy.

This is exactly what we want from the short straddle, for the stock to go nowhere, just sit there twiddling it's thumbs. Gamma is our enemy and time decay is our friend. We don't want that gamma manufacturing any deltas, and we want time decay gobbling up the option value so we can keep all, or most of the premium we collected.

But the problems with shorts straddles are:


Gamma is highest at the money, and we don't want gamma.

Theta is also highest ATM; we want that, but the gamma can cause problems.

The risk is theoretically unlimited if that blinkin' underlying decides to take off

There are a number of things we can do to mitigate those risks, but I urge you not to get too carried away with the unlimited risk thingy. Remember that a straight stock purchase or short has more dollar risk of loss than an equivalent size short straddle, but the short straddle has risk in both directions.

...and just because we are trading options doesn't mean we're bloomin' stupid. The stock trader will have a stop loss, *and so will we* (or a means of defending and rescuing a profit ).


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## wayneL (24 January 2009)

The other thing about short straddles is that if you let it go to expiry, and unless the stock pins itself exactly to the strike you've written, on of your written options is going to be in the money and you will most like end up with a stock position... not what we want.

So if you do write straddles you will want to either:


Close early 
Roll out to the next expiry if it makes sense
Metamorphose it into something else as stock movements develop

Taming Gamma (a little)

Because of the high gamma of the ATM strikes of the straddle, many traders will write strangles instead. This strategy writes OTM options instead of ATM options.

For example (with XYZ trading at $50):

Instead of writing a both calls and puts at the $50 strike, the strange might be constructed by writing a $45 put and a $55 call.

This widens out the break even points, reduces gamma and lessens the risk of one option finishing ITM. This will be at the expense of a lower maximum profit (presuming the same number of options are written), but maximum profit instead of being bang at $50, will be anywhere in between $45 and $55.

I do write straddles sometimes, but more often than not morph them to strangles via trading vertical spreads over the top.

Now we are firmly on the trail of the Condor.


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## wayneL (29 January 2009)

The main objection to short straddles and strangles is the supposedly "unlimited" risk. I don't necessarily go along with that a 100%, but in many cases it is most certainly a worry.

A few examples where a short straddle/strangle could be like playing Russian roulette:

Oil and Energy products
Gold and precious metals
Coffee in the Brazil winter
Stocks with news risk
plus pretty much everything else. 

So, how do we limit the risk on short straddles and strangles? The answer is very simple, we just go long some wings further otm than our sold strikes.

What we end up with is a sort of synthetic butterfly (if short a straddle) called an "iron" butterfly or a synthetic condor (if short a strangle) called an iron condor.

Voila! Limited risk. (BUT our greeks change a little bit)

Supposing we have the underlying at $50:

eg If you are short the $50 straddle, you buy the $45 put and the $55 call (all same expiry)

eg If you are short the $45 - $55 strangle, buy the $40 put and the $60 call.

So the natural butterfly is

Buy 1 x 45 call
Sell 2 x 50 calls
Buy 1 x 55 call (or can be done all puts) 

and bought for a debit

The iron butterfly is

Buy 1 x 45 put
Sell 1 x 50 put
Sell 1 x 50 call
Buy 1 x 55 call

and sold for a credit

The natural condor 

Buy 1 x 40 call
Sell 1 x 45 call
Sell 1 x 55 call
Buy 1 x 60 call (or all puts)

and bought for a debit

The iron condor

Buy 1 x 40 put
Sell 1 x 45 put
Sell 1 x 55 call
Buy 1 x 60 call

and sold for a credit

There are also other delta neutral strategies such as calender spreads and backspreads which we can go into if there is any interest. But I'll go into defense  of these first.


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## jackson8 (29 January 2009)

quote by waynel  "A few examples where a short straddle/strangle could be like playing Russian roulette:"

Oil and Energy products
Gold and precious metals
Coffee in the Brazil winter
Stocks with news risk
plus pretty much everything else. 


hi wayne 
thanks for all the info
i gather this i where indexes could come into play as they do not have the large volitile movement risk associated with stocks

the only thing in favor that i can see with stock is the ability to purchase to cover sold  calls if needed and to take delivery of a stock in the event of a short put being assigned . this gives a small sense of security with these strageties for myself even though taking on the stock is a large risk in itself

the inability to utilise stock as a backup has kept me from dipping my toes into the index so i will be interested in your future comments and ideas on defending these positions

gary


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## jackson8 (1 February 2009)

hi waynel

just wondering whether there will be any further instalments to this thread as i have just dipped my toes into index options condors so would be interested in any further posts

gary


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## wayneL (1 February 2009)

jackson8 said:


> hi waynel
> 
> just wondering whether there will be any further instalments to this thread as i have just dipped my toes into index options condors so would be interested in any further posts
> 
> gary




Yep,

Stay tuned Gary, I've just got to be in a concentrating mood so I dont spout bs.

Cheers


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## Grinder (2 February 2009)

jackson8 said:


> hi waynel
> 
> just wondering whether there will be any further instalments to this thread as i have just dipped my toes into index options condors so would be interested in any further posts
> 
> gary




While your waiting for one of Waynes prolific posts, something to munch on. 

Think about how you are going to manage your IC in the environment we are in, they tend to work best when there is little to no movement. Seeing that is not the case at the moment, you might want to think about tighter wings or heavier wings & be ready for adjustments.


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## jackson8 (2 February 2009)

Grinder said:


> While your waiting for one of Waynes prolific posts, something to munch on.
> 
> Think about how you are going to manage your IC in the environment we are in, they tend to work best when there is little to no movement. Seeing that is not the case at the moment, you might want to think about tighter wings or heavier wings & be ready for adjustments.




thats the bit i am interested in  how to make adjustments . at this point have only sold wotm calls with a protective bought call next strike above , but this has a very limited profit potential .  so would like to sell bit closer to the money but i dont really know of the stragety if my strike is threatened

the way i see it i could buy an itm call to protect but this would leave me open to the down side , plus the loss of time premium that i would be paying for....or open another sold call above to reduce any loss over the threatened strike but that just introduces another strike which could be taken out in the event of a big move up , or just take the hit.


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## Grinder (2 February 2009)

jackson,

There's so many possible adjustments you could make, none more superior than others, all depends on your view at any given time & your comfort level. Manage your position closely & continue to ask yourself whether you still want to be in the trade as the underlying moves towards your strike. I tend to manage IC as a complete portfolio, looking to stay as delta neutral as possible across many strikes & different months. Run possible scenarios of what the underlying could do to your IC & model how different adjustments can change your R/R payoff then decide how comfortable you are with a new strategy.

Remmember, going wotm might have a higher probability of success but how will it effect your IC when the 'black swan' comes along? Payoff diagrams come in handy for these type of scenarios.


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## jackson8 (2 February 2009)

Grinder said:


> jackson,
> 
> There's so many possible adjustments you could make, none more superior than others, all depends on your view at any given time & your comfort level. Manage your position closely & continue to ask yourself whether you still want to be in the trade as the underlying moves towards your strike. I tend to manage IC as a complete portfolio, looking to stay as delta neutral as possible across many strikes & different months. Run possible scenarios of what the underlying could do to your IC & model how different adjustments can change your R/R payoff then decide how comfortable you are with a new strategy.
> 
> Remmember, going wotm might have a higher probability of success but how will it effect your IC when the 'black swan' comes along? Payoff diagrams come in handy for these type of scenarios.




okay thanks for that grinder
i realise  that there is no magic pill and experience is the best teacher sometimes ,  so will take all onboard and do as much research as possible
gary


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## mazzatelli1000 (8 February 2009)

Grinder said:


> While your waiting for one of Waynes prolific posts, something to munch on.
> 
> Think about how you are going to manage your IC in the environment we are in, they tend to work best when there is little to no movement. Seeing that is not the case at the moment, you might want to think about tighter wings or heavier wings & be ready for adjustments.




Howdy folks
Quick in and out

I also like Cottle's approach of breaking the Condor down into a row of butterflies and selling them off as the underlying vists the various apexes.

Some food for thought 
Flying again tomozz
Out!!!! and Good Luck!!!!!


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## wakk (17 February 2009)

Thanks for sharing wayne

look forward to continuation of this


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## mitchflem (23 February 2009)

Hi,

This is my first posting on the forum.

I have been writing naked Calls over the XJO for almost a year now with great success.  They are far OTM and to date I have stuck with the direction of the market ...down...thus have not written Puts.  The Put premiums are much more tempting but I have tried to be very conservative and not let GREED take over. (Although when I was using condors the income was insufficient!)

My research has shown that the probability of being hit at my strike is low (historically) but I am becoming more concerned that the market may jump up sharply in any given month once sentiment turns.

Does anyone know of a "black swan" that occurred and the market rose dramatically?   ie. 1987 type shock


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## wayneL (23 February 2009)

mitchflem said:


> Hi,
> 
> This is my first posting on the forum.
> 
> ...




That's interesting and a sharp move, but it's not delta neutral.

We need another thread for this type of trading.

****

I've just been in the middle of moving house and whatnot. Assoon as I get that, and some other stuff out of the way, we can crack on with this thread... and perhaps another one as per mitchflems point.


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## cutz (31 March 2009)

Hi All,

What are peoples thoughts on trading iron condors, is it a good idea to re-enter a short position after its been closed out ? (i.e. closing the short put on market surge then re-entering on a reversal  ) I’ve been trawling the net and it seems that this strategy is a no-no.

Any comments on this situation?


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## jackson8 (31 March 2009)

cutz said:


> Hi All,
> 
> What are peoples thoughts on trading iron condors, is it a good idea to re-enter a short position after its been closed out ? (i.e. closing the short put on market surge then re-entering on a reversal  ) I’ve been trawling the net and it seems that this strategy is a no-no.
> 
> Any comments on this situation?




as a novice i have done what you have mentioned a number of times . in particular sto twice last month and also occasionally with lgl as well.

i think it boils down to your analysis at the time and whether you still hold the long as protection which would save on having to repurchase that extra insurance leg again

maybe also time left to expiration as premium may not be worth the risk if the is period is too short  till exp

gary

added to this i sometimes question if i should just hold the short till exp as the doubleling up of fees to close then reopen another position in the same month can chew up the profits.  i have procrastinated over this a number of times


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## Grinder (1 April 2009)

cutz said:


> Hi All,
> 
> What are peoples thoughts on trading iron condors, is it a good idea to re-enter a short position after its been closed out ? (i.e. closing the short put on market surge then re-entering on a reversal  ) I’ve been trawling the net and it seems that this strategy is a no-no.
> 
> Any comments on this situation?




If you mean closing just the short put & holding the long, so then you can open a short again upon reversal I would say I don't like it. 

The position is left open at the mercy of the market. eg: might not get the reversal & end up eroding your long thus reducing your original profit or taking a loss overall.

Market might reverse but not enough or quick enough, to snap up sufficient extra premium for the risk involved. Would leave a descent size gap in between strikes & still erode the long with a larger risk. 

Overall, too many uncertainties for my liking. Would prefer to just close out the winning bull put spread & not re-enter a new spread but instead take profits off the table then work on defending the other side if need be. 

Taking risk off & locking in profits whenever I can.



jackson8 said:


> as a novice i have done what you have mentioned a number of times . in particular sto twice last month and also occasionally with lgl as well.
> 
> i think it boils down to your analysis at the time and whether you still hold the long as protection which would save on having to repurchase that extra insurance leg again
> 
> ...




Word of advice Gary, holding till expiration is a recipe for disaster in my opinion. Sure the fees eat into the profits, but if you get hit by the menacing black swan you won't be thinking about that anymore or much of anything else. Risk management is the key, the profits will come if you manage the risk.


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## cutz (1 April 2009)

Thanks for the inputs guys,

I see your point Grinder, I actually re-entered the short put leg but at a higher strike to make it worthwhile, but of course the original long wings are too far away so I had to buy wings into the next month, so I guess end result, diagonal spread.

As you suggested I should have also closed out the original long puts as i think they were still worth something last week.


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## Grinder (1 April 2009)

like the diagonals... they're harder to manage but can be worthwhile, and now you have some lottery tics (longs) up your sleeve.


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## Beenjammin (11 April 2009)

Good on you Wanel for taking the time to deliver such a well thought out and expressed series of posts. Having read a lot of texts on the subject your explanations are probably the clearest I have seen. I think you should reconsider your John Waters signature tag!

OK, four questions here, each of them sure to elicit a range of viewpoints so I hope this doesnt obscure the intent of this tread by sidetracking it...if it does Im happy for a moderator to move it to a separate thread. Here goes:


Im curious how people employing a butterflies/condors strategy try to displerse risk - both horizontally (ie  writing multiple butterflies on the same underlying with the same expiration date as the price moves through strike points) and vertically (across multiple underlying equities/indicies). 

Considering the above, how many butterflies/condors do people feel comfortable managing at at any given time? Obviously this depends on if you are trading FT or PT - what is the general view on how any positions for a single human being are manageable? (mind you I dont think PT options trading would be easy if you have a FT job! More power to you if you are game enough to do this!)  

Im also interested in how others set the distance between the long and short positions on each wing. Modelling these two strategies in excel shows the further the long position is form the short, the greater the max profit, however the breakeven is always a bit further still behind the long position and the max loss if it runs through the breakeven can get big. 

Finally, any tips for  legging in to a Butterfly or Condor? Im always worried about getting stuck without finding a reasonable price (or any sellers at all) for one (or both) of the OTM long positions. Im interested if others have similar experience or if anyone has a strategy they are happy with for managing this.
Thanks in advance!


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## cutz (11 April 2009)

Hi Beenjammin,

I’ll have a go at answering a couple of your questions, I only feel comfortable managing 2 condors at once, I now manage my risk by being heavier on the wings (thanks grinder), I prefer to leg in, i.e. last week I set up the call leg of a May ex. position, and a partial put leg which will be finished of when the correction back to 3400 occurs.

Word of warning, I’m still on L plates.

P.S. i manage 2 condors because i use commsec to manage one which keeps my iress access, otherwise i would only manage one larger condor.


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## jackson8 (11 April 2009)

hi beenjammin

As a broad answer it is probably important to dissect and fully understand each strategy completely to help try and understand its intrinsics

Your position sizing could be based on your experience and how comfortable you are with the risk you have on the table at any one time; also knowing how to adjust positions when they go against you is a major education to have to feel more confident with position size.

I don’t think there are any definitive answers to each of your questions as there are so many variables involved

As for legging in I generally use support and resistance levels for my trades and always purchase the protective call or put at the same time as selling the short.

There are a multitude of good educational options trading sites with information on every strategy anyone could possibly devise.

When I first started out I sold covered calls over stock that I owned. I had a defined potential loss of cost of shares only which was $12000...have since moved on to naked puts but always only selling an amount of contracts that I could or would be willing to purchase the shares if I needed to.

Now that I have a few dollars in the kitty am selling spreads only putting a certain $ risk in at any one month. If my profit increases then will start looking at other more complicated strategies but always containing my $ risk to what is comfortable
It only takes one trade to go badly against you to wipe out all your previous profits and this is where knowing how to make adjustments and money managment comes into play

My thoughts would be to trade one or two low risk strategies with a defined loss and learn along the way as your confidence and experience progress then take on extra positions always defining and knowing what your max loss could be

i figure that the market will always be there so have plenty of time to learn yet


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## Beenjammin (11 April 2009)

cutz said:


> I now manage my risk by being heavier on the wings (thanks grinder), .




Thanks Cutz, 

When you say "heavier on the wings" do you mean writing them further away from the strike?



cutz said:


> I prefer to leg in, i.e. last week I set up the call leg of a May ex. position, and a partial put leg which will be finished of when the correction back to 3400 occurs..




Or 2700 as probably unlikely as the case may be. Race you to the bottom. 

So hypothetically speaking you'd buy the low put and high call, and write the mid call but wait for the price to drop before writing the mid put because you are predicting some downward movement?

Thanks again.


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## cutz (11 April 2009)

G'Day Beenjammin,

In my case heavier on the wings i was referring to more contracts on the wings, it allows me to roll up in the same month if I have to.

Regarding the put leg I was referring to, I purchased 3/4 the amount of puts I normally have on but sold 1/4. I’m still feeling pretty bearish (in the short term) so I’ll complete the spread later next week if the correction happens.

What I’m doing seems unconventional, I’m open to criticism or hints.


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## mazzatelli1000 (11 April 2009)

cutz said:


> G'Day Beenjammin,
> 
> In my case heavier on the wings i was referring to more contracts on the wings, it allows me to roll up in the same month if I have to.
> 
> ...






suggestion if I may
You pretty much have a backspread on, so learn to gamma scalp if it hits your valley of death.


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## jackson8 (11 April 2009)

cutz said:


> G'Day Beenjammin,
> 
> In my case heavier on the wings i was referring to more contracts on the wings, it allows me to roll up in the same month if I have to.
> 
> ...




hi cutz
hope you dont mind me joining in the conversation
what your describing above sounds similiar to a ratio backspread of sorts 
would this be right
so you are recieving less premium but in the case of a large move you will have more downside protection and possibly some extra profit if sp drops below the longs strike ( in the case of puts )
gary

edit :looks like m got in first


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## cutz (11 April 2009)

G'Day Gary, 

I purchase more longs in case the underlying moves to my danger zone, this allows me to close out the shorts and move them closer to the wings with a higher number of contracts, so the backspread turns into a conventional credit spread. BTW, i only do this on XJO.

Mazza, I assume the valley of death is the trough of a backspread (looking at a risk graph), what would be an example of gamma scalping?


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## mazzatelli1000 (11 April 2009)

cutz said:


> G'Day Gary,
> 
> I purchase more longs in case the underlying moves to my danger zone, this allows me to close out the shorts and move them closer to the wings with a higher number of contracts, so the backspread turns into a conventional credit spread. BTW, i only do this on XJO.
> 
> Mazza, I assume the valley of death is the trough of a backspread (looking at a risk graph), what would be an example of gamma scalping?




Basically you are taking profits on deltas manufactured on your position as the underlying moves, but it mainly helps to offset the negative theta.

Ill post a video by Ron Ianeri, which I think explains it pretty well, saves me typing outhttp://www.options-university.com/Videos/GammaTrading/


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## jackson8 (11 April 2009)

hi cutz
in my own basic understanding gamma scalping would relate to the fact that as the sp or index rises to or overtakes the sold strike the higher ratio of longs will start to pick up premium exponentially.

so selling the longs would enable covering the short and possible making some profit on top

i presume this would need to happen in the near term rather than towards ex. when time premium is at its best earlier on.


----------



## cutz (11 April 2009)

Thanks guys, 

The gamma scalping mystery has been revealed.


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## mazzatelli1000 (11 April 2009)

jackson8 said:


> so selling the longs would enable covering the short and possible making some profit on top




It's a scalp, so you wouldn't necessarily sell your longs as they are required for the large move
You can neutralise gammas generated via futures/stocks/verticals etc


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## Beenjammin (12 April 2009)

jackson8 said:


> hi beenjammin
> Your position sizing could be based on your experience and how comfortable you are with the risk you have on the table at any one time; also knowing how to adjust positions when they go against you is a major education to have to feel more confident with position size.




You are very correct and thank you for re-inforcing the need to build experience in a planned and conrolled manner. 

The reason I'm asking about the number of butterflies/condors is more to do with diversification, rather than sizing. As an equity investor I would maintain a portfolio of 15 - 20 stocks. As an options trader I need to establish if this is a realistic spread to aim for long term or just too ambitious? I realise the answer will lie in my own preferences and abilities, but I would like to get some insight into what other traders are doing and how they manage diversification.



jackson8 said:


> There are a multitude of good educational options trading sites with information on every strategy anyone could possibly devise.




Ive done a lot of searching on the web, and most of the sites seem to give you the basics (eg this is a put ratio backspread, this is a short straddle, this is a long synthetic future) but not a lot on the blood & guts of day to day realities, especially in relation to the ASX. The vast majority is from our American friends. ASX ETO's are a lot less liquid than their US equivalent. Ive found it difficult to get reasonable offers accepted the further I move away from the money, and was wondering if others shared that experience and if they had a strategy for dealing with it.



jackson8 said:


> When I first started out I sold covered calls over stock that I owned. I had a defined potential loss of cost of shares only which was $12000...have since moved on to naked puts but always only selling an amount of contracts that I could or would be willing to purchase the shares if I needed to.
> Now that I have a few dollars in the kitty am selling spreads only putting a certain $ risk in at any one month. If my profit increases then will start looking at other more complicated strategies but always containing my $ risk to what is comfortable
> It only takes one trade to go badly against you to wipe out all your previous profits and this is where knowing how to make adjustments and money managment comes into play




Im especially interested when you say you had a defined potential loss of the cost of the shares for your covered calls. Ive been wrestling with developing a stop loss strategy that doesnt whipsaw me in and out.....did you ever try stop loss strategy for covered calls?

Thanks 
B


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## cutz (12 April 2009)

Beenjammin said:


> The reason I'm asking about the number of butterflies/condors is more to do with diversification, rather than sizing. As an equity investor I would maintain a portfolio of 15 - 20 stocks. As an options trader I need to establish if this is a realistic spread to aim for long term or just too ambitious? I realise the answer will lie in my own preferences and abilities, but I would like to get some insight into what other traders are doing and how they manage diversification.




G'Day Beenjammin,

I also maintain a diversified portfolio of stocks but as far as options trading goes i only stick with the 5 series which isn't to bad to manage and it provides me with reliable income.



Beenjammin said:


> ASX ETO's are a lot less liquid than their US equivalent. Ive found it difficult to get reasonable offers accepted the further I move away from the money, and was wondering if others shared that experience and if they had a strategy for dealing with it.




Yeah, i have to agree with you there, I don’t think there’s much that can be done about this, in my experience with XJO out of the money options place your order at a reasonable volatility and you may find that the order will get filled eventually, its worked for me a few times, not the best way of doing business but I guess it’s the price we pay trading on the ASX.
I do dabble on the US exchanges but my positions are extremely light, I’m apprehensive about putting on anything decent because I can’t devote enough screentime overnight.


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## Grinder (12 April 2009)

looks like we have an interesting discussion goin on here. Will have to play alittle catch up quickly.

Your've asked some solid Qs BJ, will do my best to touch on each. 

1. As far diversification goes I put my ICs on different months looking to adjust into different species when required. Try and spread as much delta around as possible in different time frames. When positions start to show signs of being threatend I make adjustments to bring them back to my comfort zone. 
2. Managing position size is'nt too much of problem as i have the time, so I've got anywhere b/n 4-8 10 lot ICs on at any given time.
3. Choosing strikes is based on S/R, Std dev & greeks set up, difficult to say exactly as all depends on what Im holding at any given time & my perception of the market. Cutz mentioned about the heavier wings (backspread), again depending on how I see things they could be mild or alot heavier, leaning towards a slingshot type set up. Going wider b/n strikes can give you room for adjusting or loading up on wings without foregoing too much premium.Too many factors to list here, think you get the point.
4. No real secrets here(that i know of anyway). Like to get a complete IC on at once, or 2 seperate spreads simultaneously. If I don't get what I want, look to go in on verticals & finally legging in if suits the situation. Try whatever gets you the best fill, sometimes I have to fly fish for half the day & still no bites.

there's so much to it that it's difficult to give a full explanation of trading them, alot of it is what is built up from experience (trial & error) & knowing where & when to make moves for my own comfort zone.

hope it helps.


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## jackson8 (12 April 2009)

Hi beenjammin

For myself purchasing some shares and then selling calls over them was my introduction to the options market. I took no insurance eg.covered call collar and took the downside risk of the sp falling.  With the recent volatility of the market my approach has now turned to one of trying to create an income without having to bare the cost of carry of owning shares.  My shares have now been assigned and I will be happy to have the cash back in the account.

When I first entered covered call positions I looked at what it was that I wanted to achieve with the positions
Eg. Passive income whether with or without downside protection (collar) so my loss could be defined with the added possibility of sp appreciation

But with the sp whipsawing up and down so much recently I found myself constantly trying to adjust the calls eg rolling up, rolling down and also rolling out to further months that in the end I am more than happy to accept assignment 

Just now I am only trading bull put credit spreads (half of the IC) as this gives me the opportunity of making one of two choices should the position go against me. Accept the loss or take possession of the shares. The latter is a last resort as then I would probably start the covered call procedure all over again. But the overall plan is to make a passive income without ever having to own any shares.

I think that for anyone who has been trading options over the last six months or so with the volatility of the market would have been the best learning experience possible.

On a note of what not to do and this relates to another thread which has been closed

The advocating of throwing your whole trading capital at once into one position there by with the potential of wiping all your capital out in your first trade.

Great returns if the trade goes right but disastrous if it goes against you and these are newbie’s who probably have no experience in the market whatsoever who are being misled by the get rich schemes that some people may or may not be  promoting


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## mazzatelli1000 (13 April 2009)

BJ

Diversification could be approached on a Greek based basis - i.e. risk instead of underlying

Many like to be exclusively short WOTM gamma e.g. naked short options, credit spreads. Dangerous stuff!!

Having many butterflies on the one underlying will synthetically be having a very wide condor
The wider the condor the crappier the R:R becomes. Trader's choice and personally I don't like those.
You could also save commissions trading the one condor instead of purchasing multiple butterflies especially in the Oz market

Management of trades will come from personal preference. Anything more than 10 would be getting a little too crazy. 

In terms of distances between the long and short strikes, the further out your long strikes are, means that there are many more embedded verticals in the position. Looking at some of them individually the R:R would probably turn you off.


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## cutz (13 April 2009)

mazzatelli1000 said:


> Condor down into a row of butterflies and selling them off as the underlying vists the various apexes.




G'Day Mazza glad you're back on.

I can't get my head around this one, if it's not to much bother and you've got the time could you show us how this is done.


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## Beenjammin (13 April 2009)

Grinder said:


> looks like we have an interesting discussion goin on here. Will have to play alittle catch up quickly.
> 
> Your've asked some solid Qs BJ, will do my best to touch on each.
> 
> ...




Great stuff Grinder, many thanks.

Can you please explain a little more on "adjust into different sepcies"? Are you referring to different strategies, different underlyings, something else?

Thanks


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## Beenjammin (13 April 2009)

jackson8 said:


> Hi beenjammin
> 
> For myself purchasing some shares and then selling calls over them was my introduction to the options market. I took no insurance eg.covered call collar and took the downside risk of the sp falling.  With the recent volatility of the market my approach has now turned to one of trying to create an income without having to bare the cost of carry of owning shares.  My shares have now been assigned and I will be happy to have the cash back in the account.
> 
> ...





Thanks Jackson,

This is most helpful, filling in a gap that Im sure many home traders face - the ability to bounce things off more experienced peers, and hear about others experiences, lessons learnt, and descisions made based on those experiences. Very valuable, its helping me validate my experiences.


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## Beenjammin (13 April 2009)

mazzatelli1000 said:


> BJ
> 
> Diversification could be approached on a Greek based basis - i.e. risk instead of underlying
> 
> ...




Thanks Mazza!

Thanks for the note on diversifying based on Gamma. Out of intererst, do you ever consider the industry verticals you are exposed to as well? What about the beta of the underlying, do you bother or just assume its priced into the vega?

Appreciate the input re number of trades. Just for clarity, is that 10 condors or 10 contracts?

Looks like Im off to do some more research on diagonals so I can better understand your comments on the embedded verticals - im with Cutz here, a little unsure on what you are referring to so if you've got some time to give a little more detail it would really be appreciated.

Thanks!
B


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## mazzatelli1000 (13 April 2009)

cutz said:


> G'Day Mazza glad you're back on.
> 
> I can't get my head around this one, if it's not to much bother and you've got the time could you show us how this is done.




Hey Cutz,
Just back for Easter

E.g. 170/175/185/190 Condor 
Assume 5pt strike increments


```
Strikes
170      175     180    185    190
+1      -2      +1                      Butterfly 1: 170/175/180  
          +1     -2      +1              Butterfly 2: 175/180/185  
                 +1     -2      +1      Butterfly 3: 180/185/190  

+1        -1      0      -1      +1     Total: Add down = 110/115/125/130 Condor
```

Butterflies have maximum profit at middle strikes/apex with very little time to expiration
If the prices are attractive enough, you could sell off a butterfly and take money off the table/lock in profits
E.g. hits XYZ $175 sell off the 170/175/180 fly

XYZ could tank from here, but you have reduced the loss/or book a small profit 
If it moves back up to $180, you could sell off the 175/180/185 fly

In hindsight it would be better to leave the condor untouched if it comes back into the 180 range

Just another way to manage


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## cutz (13 April 2009)

Thanks mazza,

I'll study it in detail when i can get some quiet time tonight.


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## sails (13 April 2009)

mazzatelli1000 said:


> Hey Cutz,
> Just back for Easter
> 
> E.g. 170/175/185/190 Condor
> ...




Hi Mazza - good to see you back even it's only for Easter 

It looks like your butterflies are overlapping rather than sharing long strikes?  I have done multi strike butterflies, but they only shared long strikes - otherwise did not overlap as in your illustration.  If you took your butterfly No. 2 out and just used Nos. 1 & 3.  I then finished off with cheap debit spreads at each end.  Technically, it could otherwise be described as a row of sold flies.  However, the entire creature is vega positive.

The set up works best when the markets are volatile and IVs holding up to rising.  It works specially well when the market comes screaming down, one can sell more flies at the lower end and keep taking in more credit.  As expiry approaches s begin to collapse in OTMs, it is possible to buy to close any winning bear spreads above (and leaving in cheap bull spreads alone) in the event that the market would turn and run the other way into expiry (which often happens).  In fact, if the market is below the lowest put debit spread and you have good reason for a reversal, one can add a put credit  for a very healthy credit (or cheap bull call) to complete the lower fly and often completely remove all risk and/or lock in profit.  Still leaves some cheap bull spreads above for extra profit.

EDIT - hope the above makes sense - I typed it out fairly quickly!

Cutz, the way Mazza has carded up those positions in his illustration is similar to what I learned from Cottle's book.


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## mazzatelli1000 (13 April 2009)

sails said:


> Hi Mazza - good to see you back even it's only for Easter
> 
> It looks like your butterflies are overlapping rather than sharing long strikes?  I have done multi strike butterflies, but they only shared long strikes - otherwise did not overlap as in your illustration.  If you took your butterfly No. 2 out and just used Nos. 1 & 3.  I then finished off with cheap debit spreads at each end.  Technically, it could otherwise be described as a row of sold flies.  However, the entire creature is vega positive.
> 
> ...




Btw post should read Total:Add down 175/180/185/190 Condor 
Yep, this is Cottles baby. He likes to dissect the embedded flies from positions

Hey sails,the position you describe - does it look like this roughly
Using numbers above
1) Short 175/180/185 fly
2) 170/175 spread
3) 185/190 spread


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## mazzatelli1000 (13 April 2009)

Beenjammin said:


> Thanks Mazza!
> 
> Thanks for the note on diversifying based on Gamma. Out of intererst, do you ever consider the industry verticals you are exposed to as well? What about the beta of the underlying, do you bother or just assume its priced into the vega?
> 
> ...




I do consider the industry, but indirectly through filters I use to select candidates.

Beta is not involved in Vega calculations. It is more a correlation measure. I think you are trying to mention volatility here?

Yes I was referring to 10 positions e.g. 10 condors.

Embedded verticals 
E.g. You considered widening long strikes
so instead of say a 120/121 bear call spread
You are considering a 120/125 bear call spread
You will see there is more profit because the 125c is cheaper than 121c - BUT you're risk has now increased also

the 120/125 spread has the following embedded verticals
1) -120/+121 Bear Call spread
2) -121/+122 Bear Call Spread
3) -122/+123 Bear Call Spread
4) -123/+124 Bear Call Spread
5) -124/+125 Bear Call Spread

All the strikes in between cancel each other out and you are left with 120/125spread.


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## sails (13 April 2009)

mazzatelli1000 said:


> Btw post should read Total:Add down 175/180/185/190 Condor
> Yep, this is Cottles baby. He likes to dissect the embedded flies from positions
> 
> Hey sails,the position you describe - does it look like this roughly
> ...




Yes, something like that - and it had to be cheap.  It does need strong moves to work well.  I'm not completely convinced it is a good way to go, but it was fun trying it out.  Certainly way too expensive in the Oz market with fees.  It's not a set and forget as one needs to be watching to make adjustments.


----------



## cutz (13 April 2009)

Thanks mazza and sails,

Position dissection and carding up described nicely.

Mazza, do you only use manual methods to check out total position or have you got software that accepts numerous/unlimited legs.


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## mazzatelli1000 (14 April 2009)

sails said:


> Hi Mazza - good to see you back even it's only for Easter
> 
> It looks like your butterflies are overlapping rather than sharing long strikes?  I have done multi strike butterflies, but they only shared long strikes - otherwise did not overlap as in your illustration.  If you took your butterfly No. 2 out and just used Nos. 1 & 3.  I then finished off with cheap debit spreads at each end.  Technically, it could otherwise be described as a row of sold flies.  However, the entire creature is vega positive.
> 
> ...




Thanks for sharing your management of that position with us!!!

I especially like the bit about selling the flies in between when the market is tanking.

I have been running a few simulations of it and I seem to be getting a negative vega, positive theta creature which is fairly delta neutral at the start. The position I suggested above seems to favour drops in IV  All of which is the opposite of what you have described LOL
The only thing that seems to reconcile is that skew to the downside is favourable

I think I am looking at a different configuration to yours!!

Have you ever come across skip striking the flies to have yet another configuration of the "M" spread (hehe)

e.g. 170/175/180 put fly --- +2/-3/+1 
180/185/190 call fly --- +1/-3/+2

The characteristics are like that of a condor. 

Cutz
I have software that accepts numerous legs and products. But the software is catered towards other markets.

I think Hoadley has the Open Positions module that lets you enter numerous legs.


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## Grinder (14 April 2009)

sails said:


> Yes, something like that - and it had to be cheap.  It does need strong moves to work well.  I'm not completely convinced it is a good way to go, but it was fun trying it out.  Certainly way too expensive in the Oz market with fees.  It's not a set and forget as one needs to be watching to make adjustments.




Yep, way too expensive for Oz market. Like your set ups though, have tried modelling simmilar & always ends up as a croc spread (eating up the spread dueto fees)



mazzatelli1000 said:


> Have you ever come across skip striking the flies to have yet another configuration of the "M" spread (hehe)
> 
> e.g. 170/175/180 put fly --- +2/-3/+1
> 180/185/190 call fly --- +1/-3/+2
> ...




mine look more like batman. I have the backspreads without the single strangles, would pick them up later if needed for protection. 



mazzatelli1000 said:


> Cutz
> I have software that accepts numerous legs and products. But the software is catered towards other markets.
> 
> I think Hoadley has the Open Positions module that lets you enter numerous legs.



 as does optionsoracle. Not as good as hoadleys, but a free modeller nevertheless.



Beenjammin said:


> Great stuff Grinder, many thanks.
> 
> Can you please explain a little more on "adjust into different sepcies"? Are you referring to different strategies, different underlyings, something else?
> 
> Thanks




different bird species can be BWB, butterflys or others... & different strategies can be other adjustments. Start of with a version of an IC but could end up with just about anything as the market moves, backspreads, strangles, even switch to a long condor if my view changes.


----------



## sails (14 April 2009)

mazzatelli1000 said:


> Thanks for sharing your management of that position with us!!!
> 
> I especially like the bit about selling the flies in between when the market is tanking.




I have never shared it simply because I'm not convinced it's a good thing to do - especially in Oz because of the fees.  But it was a lot of fun - until I realised how much I had run up in fees!



> I have been running a few simulations of it and I seem to be getting a negative vega, positive theta creature which is fairly delta neutral at the start. The position I suggested above seems to favour drops in IV  All of which is the opposite of what you have described LOL
> The only thing that seems to reconcile is that skew to the downside is favourable
> 
> I think I am looking at a different configuration to yours!!




Yes, I think you may have it a bit different.  Nothing wrong in yours - after all it's all just about trading puts and calls.

As an example, I had one of these on in the Oz market about Jan last year in BHP.  I positioned the flies as follows: the longs were $2 apart and the shorts $1 from the longs.  Going my memory now (could look up my records if you would like more exact info), I think I had about three long flies with two debit spreads on each end and the debit spreads were joined on to the upper and lower flies. 

 BHP came tumbling down a day or two before expiry and I had reason to believe it might have reversed to go up into expiry - which it did.  Unfortunately, the MMs refused to put any quotes up on the board all day on the day of the reversal, apparently because they didn't like the volatility.  I had never had this happen before, so was somewhat unprepared.  I tried to add the put credit spread on underneath, but the MMs wouldn't take the other side at my prices.  Below a certain credit, it's not worth the risk should the market continue to fall. 

Needless to say, I decided to quit the Oz options market and proceeded to set up with TOS.  I found NDX worked well with the system, but with things getting very busy on the home front, I had to stop.  These sorts of positions  need adjustments at the right times, so it didn't work to have the market trading while I slept.  Neither did I want to be woken in the night due to the pressures happening during the day time in Oz.

Looking back on the BHP trade, I realised that the real profit actually came from the put credit spread when it looked like BHP was reversing to move up into expiry.  In hindsight, I could have simply put the credit put spread on and purchased a cheap bull call spread a little higher.  So much cheaper in fees, and less investment to protect.  I think the fees for that month were in excess of $1000.  That is simply too much to pay for a limited profit position.




> Have you ever come across skip striking the flies to have yet another configuration of the "M" spread (hehe)
> 
> e.g. 170/175/180 put fly --- +2/-3/+1
> 180/185/190 call fly --- +1/-3/+2
> ...




Also similar is the broken wing butterflies - normal quantity as a normal fly, but the OTM wing is taken even further OTM - I think we have discussed the similarities before.  Doubled up they become aka Batman spreads?  Some of this sort of thing is discussed a bit on the Yahoo Option BWBs and Collars group.  Michael Catolico is one of the contributors and is an ex US market maker.  His mock trades are interesting to follow, but due to the number of adjustments - hopeless for the Oz market.  With the ASX charge of $1.12 per contract in ADDITION to brokers fees - it's pretty hopeless.  Not to mention the MMs that won't put up quotes until somewhere in the first hour  - or the slippage often incurred in the Oz Market.   Sorry - end of rant.  

Actually, wouldn't do the butterflies I describe above with IB either due to assignment risk with some shorts going ITM and they give so little time to re-adjust the position.

I have also traded some diagonals and long line, multi strike calendars with extra wings.  These type of calendars work wonders if IV rises a bit, but easy to lose money quickly if IV falls.  

Diagonals are an interesting set-up.  I did quite a large one of these in the first twelve months or so of my option trading on NCP now (NWS).  Put it on just before Murdoch decided to take the company to the US.  It rocketed up   Being so new at it, I decided to close out - it was Thursday morning before the Easter weekend and the MMs obviously sensed I was a bit desperate so didn't get a good fill on the exit.  Anyway, followed the trade through with "what-ifs" and actually found that if I had kept rolling the short call up and out, the position would have still returned a profit.  But then with the frenzy of the move, I think IV would have remained farily high which would have helped as well.  Didn't understand much about the greeks at that stage!


----------



## jackson8 (28 April 2009)

mazzatelli1000 said:


> Hey Cutz,
> Just back for Easter
> 
> E.g. 170/175/185/190 Condor
> ...




Hi mazza

Just referring to this earlier post concerning fly’s

Are you talking about placing each of the fly’s individually and if so are they bought at the same time or as the market moves

Or is the condor at the bottom the position that can be placed in it own entirety and would this in effect be the same position

Looking at it some of the strikes seem to cancel each other out

Would the individual trades allow more scope for adjusting even though incurring higher broker fees to place?

Thanks
Gary


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## Grinder (28 April 2009)

essentially models the condor, but allows you to migate the risk by taking off positions the underlying moves. In Oz embedded bflys will eat up your position with all the fees involved in adjustments. Go to this link http://www.riskdoctor.com/ will keep you busy.


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## cutz (28 April 2009)

I'll also have a go Gary,

Please correct me if i'm wrong anyone,


The butterflies are put on in one hit, after dissection the risk profile looks like a IC.
Because the butterfly has it's max profit zone at the strike (after some time has passed of course) you close out each butterfly as the strikes are visited.


----------



## sails (28 April 2009)

There is no point to putting all those flies on where some of the trades will simply cancel each other out.  The broker, the ACH and MMs will love your donation of fees and slippage, but you will technically end up with the condor as the card-up shows. It is one the advantages of carding up positions so you don't pay unnecessary fees. 

In my version of Iress (as is the case with IB) you don't buy or sell to open or close.  A sell simply cancels a buy and vice versa.  Same deal as with stocks or futures.  Why some brokers complicate issues with always adding "to open" or "to close" is beyond me.

Even if your broker allows an open buy and sell on the same strike/month - what's the purpose?  They will move together.

There are many different strategies that have embedded positions.  The diagonal is another - it is actually a calendar spread + a credit spread where the front month long of the credit spread is on the same strike as the short of the calendar.  That might help to put it into perspective...


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## cutz (28 April 2009)

OK I see how I’m totally wrong with initiating the position as multiple butterflies. So in theory you start off with a multi contract condor and remove butterflies as time goes by ?

Not something I’d consider doing on the oz market but when you look at options on SPY in the US with spreads only a few points apart it seems like an interesting concept.

Yeah, have to agree with you sails regarding buy to open ect. on the comsec order pad, i know i shouldn't blame my broker but that has been a cause of to many order entry errors.
On the other hand TWS and it's 3 click system i haven’t had any problems, its a thing of beauty.


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## jackson8 (28 April 2009)

thanks guys for all your replies

i am currently reading in cottles book about the structure of butterflys and carding them up but sometimes takes a few readings before it starts to make sense

i see all of these strategys as a combination of buys and sells (no greek speak ) with the ability to weight  towards the position where you may speculate  the price is going to head

any thoughts on long fly over wider strikes eg. xjo 3500;3700;3900

costs more to put on but has a wider profit zone 3500;3900

gary


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## jackson8 (28 April 2009)

sorry that profit zone
would be aprox 3600/3800 not



costs more to put on but has a wider profit zone 3500;3900


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## cutz (28 April 2009)

Hi Gary,

I'll leave that to the experts as i've never put on a butterfly (yet) but personally a more attractive range of strikes would be a few levels down, i think you may also have to consider market outlook and it seems like we're long overdue for a correction. (Note;personal opinion only i'm more than likely to be wrong  ).

Which leads me to another question, you guys that put on flys, do you consider market outlook or are strikes set based on IV and probability of loss zones touched based on standard distribution the day the position is put on ?


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## jackson8 (28 April 2009)

cutz said:


> Hi Gary,
> 
> I'll leave that to the experts as i've never put on a butterfly (yet) but personally a more attractive range of strikes would be a few levels down, i think you may also have to consider market outlook and it seems like we're long overdue for a correction. (Note;personal opinion only i'm more than likely to be wrong  ).
> 
> Which leads me to another question, you guys that put on flys, do you consider market outlook or are strikes set based on IV and probability of loss zones touched based on standard distribution the day the position is put on ?




thanks cutz

those strikes are just chosen at random as an example 
not actually looking for pointers on direction of market as such.

have not placed any flys either but am looking into as the profit potential is attractive if finishing at sold strike

trying to widen my strategy's from just naked puts and bull put spreads.


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## sails (28 April 2009)

Gary, I haven't had a look at your specific butterfly - bit busy now so will have a look later.  Anyway, here's a few quick ideas on butterflies - 

Butterflies can be used as bullish if placed above and bearish if placed below and are cheaper if they are placed OTM.  If they are narrow, they rarely make much profit prior to expiry.  With something like BHP, a fair bit of premium stays in the ATM options even on expiry day, so it can make butterflies very frustrating.  Although, if they are wider, it do produce profit a little closer than at closer strikes.

Butterflies can also be adjusted quite easily.  They can be moved entirely or one of more of the legs can be moved.  Sometimes one can morph into a butterfly from a losing long call to lower the breakeven without adding significantly to the debit.  

I did post somewhere the way I have used them recently - but was was technically running a reasonable line of short butterflies during times of volatility and adjusting them as the market moved.

I'm reluctant to do them in the Oz market any more due to the hefty fees and slippage here which eats too heavily into their limited profit margin.  

I have heard that some like to place a wide butterfly with the lowest long leg ATM and the sell legs higher (often where IV is higher) as a bullish position and it is helped by falling IV as well as direction.

There are lots of ideas with them - they are not a holy grail and I think it's a personal thing whether you like them or not.  Best to have a play with them in something like Hoadley - even paper trade them to get a good feel for the positives and negatives.  It's just another strategy that probably helps with the general understanding of options and adjustments.


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## Grinder (28 April 2009)

jackson8 said:


> thanks guys for all your replies
> 
> i am currently reading in cottles book about the structure of butterflys and carding them up but sometimes takes a few readings before it starts to make sense




stick with it, it is a hard read (for me anyways). You probably won't ever use alot of the stuff he discusses but will be glad to know it, will give you a broader understanding. On his forum you can access his teachings that are sent to you each day, can't remmember exactly which section it is in. Will help in the process of digesting the info.


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## mazzatelli1000 (14 May 2009)

sails said:


> Michael Catolico is one of the contributors and is an ex US market maker.  His mock trades are interesting to follow, but due to the number of adjustments - hopeless for the Oz market.




Ah yes Mr Catolico,  I have read his posts - particularly about the good, bad and ugly trader LOL




sails said:


> I have also traded some diagonals and long line, multi strike calendars with extra wings.  These type of calendars work wonders if IV rises a bit, but easy to lose money quickly if IV falls.
> 
> Diagonals are an interesting set-up.  I did quite a large one of these in the first twelve months or so of my option trading on NCP now (NWS).  Put it on just before Murdoch decided to take the company to the US.  It rocketed up   Being so new at it, I decided to close out - it was Thursday morning before the Easter weekend and the MMs obviously sensed I was a bit desperate so didn't get a good fill on the exit.  Anyway, followed the trade through with "what-ifs" and actually found that if I had kept rolling the short call up and out, the position would have still returned a profit.  But then with the frenzy of the move, I think IV would have remained farily high which would have helped as well.  Didn't understand much about the greeks at that stage!




I find diagonals when I have no spot bias, better ATM
The back month takes advantage of accumulation in gamma (speed) and long vol, while front can be shorted ATM gamma and shifted like in your example.

Eek at aussie MM's - man they are a tough lot

EDIT: Delayed responses I know


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## sails (14 May 2009)

mazzatelli1000 said:


> Ah yes Mr Catolico,  I have read his posts - particularly about the good, bad and ugly trader LOL
> 
> I find diagonals when I have no spot bias, better ATM
> The back month takes advantage of accumulation in gamma (speed) and long vol, while front can be shorted ATM gamma and shifted like in your example.
> ...




lol - some mixed messages there about Mr Catolico.  Not sure exactly what you mean.  

I think he said he took on way too much risk at one stage as an MM and apparently took a pretty big hit.  I have appreciated his sharing his knowledge so freely and seems to take pretty good care of risk in his trading - or at least last time I looked.  Haven't read any of his posts for a long time now.


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## mazzatelli1000 (15 May 2009)

sails said:


> lol - some mixed messages there about Mr Catolico.  Not sure exactly what you mean.
> 
> I think he said he took on way too much risk at one stage as an MM and apparently took a pretty big hit.  I have appreciated his sharing his knowledge so freely and seems to take pretty good care of risk in his trading - or at least last time I looked.  Haven't read any of his posts for a long time now.




Im confused too
I don't think I was attributing those descriptions to him
LOL

I was referring to one of his posts titled "good, bad and ugly trader"

If you were a good trader - you were lucky
Ugly trader - you grounded out profits 

And to sum it up, not everyone could be a successful trader
WayneL has rehashed it on this forum in '07 
Article


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## mazzatelli (27 August 2009)

Double Flies - "M" spread

To add continuity to sails discussion in earlier posts


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## Fox (1 September 2009)

sails said:


> As expiry approaches s begin to collapse in OTMs,



Hi Sails, 

Can I ask what "s" means, when you say "s begin to collapse in OTMs"? 

Thanks,
Fox.


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## sails (1 September 2009)

Fox said:


> Hi Sails,
> 
> Can I ask what "s" means, when you say "s begin to collapse in OTMs"?
> 
> ...




lol - must have been a typo & no-one else has picked it up either

Will go back through the thread & work it out... 

EDIT - been back through that post of mine and "premium begins to collapse"  would fit the context.


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## Fox (1 September 2009)

Thanks for clearing that up. I was initially thinking that 's' was some sort of greek like (s)igma or (s)tandard deviation. Then I thought that perhaps it meant (s)hare, as in the underlying. All possibilities I had did not quite fit.

Now, I'll try to digest the rest of your post. Cheers.


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## Fox (5 September 2009)

mazzatelli1000 said:


> I also like Cottle's approach of breaking the Condor down into a row of butterflies and selling them off as the underlying vists the various apexes.



Mazza, was this from Cottle's earlier books? 

The book I have is Options Trading: The Hidden Reality (OTTHR). In OTTHR, he discusses selling off the butterflies in a Pregnant Butterfly (Two-Strike Butterfly). The concept would be similar to selling of butterflies from an IC.

I was just curious which of his books the idea of breaking the IC down was discussed.


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## cutz (5 September 2009)

Fox said:


> Mazza, was this from Cottle's earlier books?
> 
> The book I have is Options Trading: The Hidden Reality (OTTHR). In OTTHR, he discusses selling off the butterflies in a Pregnant Butterfly (Two-Strike Butterfly). The concept would be similar to selling of butterflies from an IC.
> 
> I was just curious which of his books the idea of breaking the IC down was discussed.




Hi guys,

Hope you don't mind me jumping in,

Fox,

It's also in the latest edition, Stretched out Condors, bottom of page 169.


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## Fox (18 September 2009)

From post #39:



cutz said:


> I purchase more longs in case the underlying moves to my danger zone, this allows me to close out the shorts and move them closer to the wings with a higher number of contracts, so the backspread turns into a conventional credit spread.



Cutz, I finally understand your post. Took me a while, but the lights finally came on! What a clever idea. I'm going to put this to practice. Could have saved me from numerous disasters in the past, I'm sure.



cutz said:


> Mazza, I assume the valley of death is the trough of a backspread (looking at a risk graph), what would be an example of gamma scalping?



How often have you been stuck in the valley of death? Is it common, or rare? Would, say, 1 in 10 rescues result in being in the valley? I'm just curious how often you have experienced this. Also, did you manage to gamma scalp your way out of trouble?


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## cutz (18 September 2009)

Fox said:


> How often have you been stuck in the valley of death? Is it common, or rare? Would, say, 1 in 10 rescues result in being in the valley? I'm just curious how often you have experienced this. Also, did you manage to gamma scalp your way out of trouble?




Hi Fox,

Yeah it's happened to me a couple of times one way markets are the worst, the most recent still stuck in my memory was early this week, the big moves caught me out so i just closed the position which was about to expire and set up a fresh one for Oct.

The bit about moving the shorts up towards the wing i've only done once with a spread that was small to start with, in hindsight gradually removing shorts would have achieved better results.

Gamma scalping, i've never attemped it on XJO's as there's no suitable underlying to enable tweeking of the position (IMO), playing with SPI contracts alters the risk profile too much, i'm gradually building a position on the Eurex so we'll see how it goes.

EDIT>>BTW Fox tough question to answer, most of the time what i end up with towards the end of the month is nothing like when the position was set up, ie index moves up, close out short puts, close out some long puts, lay on a fresh set of puts at a higher strike, close out a short call, ect. ect. , this is why most end up overseas markets where the spreads are nicer.


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## nickleeson88888 (1 October 2009)

hi guys,

i've got a bit of a dilemma here, 

trying to work out a delta for a uni assignment.

we are shorting 1000 calls at $9.63 amd buying delta number of stocks = 880 stocks at $60.69 (delta = 0.88 from the financial review).
we borrow $43,777.20 to pay for the remaining stocks.
that's the portfolio.

aim is to keep the portfolio delta neutral.
if the stock price falls by $0.33 the next day, we have worked out delta to be $0.24242424 (change in call price / change in stock price).

Is this the correct method to work out delta for the portfolio?

and how do we adjust the portfolio to make it delta neutral.

any help would be much appreciated.

thanks!


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## jackson8 (1 October 2009)

nickleeson88888 said:


> hi guys,
> 
> i've got a bit of a dilemma here,
> 
> ...




hi 
in its simplest form if you sell 1 contract with a size of 1000 you would times the delta of the sold strike by 1000. this is how many shares you will need to purchase of the underlyling to be neutral 

as the sp rises the delta rises towards 1 in which case you would need to recalculate how many of the underlying you would need to hold. as the sp rises further toward the sold strike price the delta will rise to 1 meaning 1 delta = 1 full share.  with the price drop you are able to sell shares to remain delta neutral to achieve the same.

in essence buying or selling quantities of the underlying to remain delta neutral at all times. this can be re-evaluated on a daily / hourly/ weekly basis whichever you choose but obviously is a very commission intensive and costly.
you can also achieve the same by using other options as an instrument to neutralize delta

like i said in its simplest form
Gary


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## wayneL (1 October 2009)

nickleeson88888 said:


> hi guys,
> 
> i've got a bit of a dilemma here,
> 
> ...




In any option combo, the "position delta" is simply the sum of all the deltas of each leg.

It's not clear what you have in your position there so I'll go through a worked example.

Long stock always has a delta of 1, Therefore 880 shares has 880 deltas. Stock price is irrelevant.

Short calls have negative deltas so you need some number of call contracts to add up to -880.

A slightly OTM call might have a delta of 0.44 (sold call -0.44) so you would need to sell two contracts to be delta neutral... 2 x 1000 x -0.44 = -880

880 + -880 = 0 Voila! Delta neutral.

If the delta of the options change through stock movement, delta will become unequal. Let's say the stock price moves up and causes the call delta to rise  to 0.6

You still have 880 deltas with the stock.

But now you have 2 x 1000 x -0.6 = -1200 deltas with the short calls.

Your position delta is now 880 + -1200 = -320 deltas

To restore delta neutrality you need to get rid of those 320 negative deltas or to acquire another 320 positive deltas from somewhere.

There are any number of ways of doing this, but the easiest way is to buy another 320 shares thereby acquiring those 320 positive deltas. -320 + 320 = 0 and back to delta neutrality.


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## mazzatelli (2 October 2009)

jackson8 said:


> you can also achieve the same by using other options as an instrument to neutralize delta




nick leeson [he was my hero too :]
If you are focused primarily on neutralising delta, then use spot. 

Using options introduces other Greeks [vega, gamma, theta, rho] as well as delta, and depending on strikes and expiry changes the nature of replication. If I remember my uni assignment, it would be focusing solely on an options portfolio + dynamic hedging with spot.

Good luck with your assignment


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## nickleeson88888 (2 October 2009)

thanks for the help guys. just want to clarify my question a bit, but first the assignment asks:

1.to identify an option you believe is mispriced.
2.develop an arbitrage, delta-neutral strategy that will make money from the mispriced derivative. detail minimum costs, and you can use as much money as you like because it's theoretically risk free and none will be lost anyway.
3.then we are responsible for adjusting the delta-neutral portfolio (for two adjustments) while recording transactions and profit/losses.




We picked RioTinto's option at random because, technically all options are mispriced. But of course we show B-S calculations indicating it's underpriced.

To make an arbitrage strategy, first we sold (because B-S model indicates it's underpriced) 1 call contract, and consequently purchased shares. the delta was 0.88 (obtained from the financial review)

(feel free to correct me if i've made mistakes along the process)

So we are shorting 1000 calls at $9.63 and buying delta number of stocks = 880 stocks at $60.69 (delta = 0.88 from the financial review).
we borrow $43,777.20 to pay for the remaining stocks.
that's our portfolio to begin with.

problem is, i'm unsure how to "maintain" delta-neutrality. is it fine to use the delta from the next days financial review?



also, when they say "close-out early", how can it be advantageous to close-out early?

thanks!


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## mazzatelli (2 October 2009)

nickleeson88888 said:


> We picked RioTinto's option at random because, technically all options are mispriced. But of course we show B-S calculations indicating it's underpriced.




Ugh. 
"Technically" they're mispriced because BSM assumptions don't hold [lognormal price density, geometric brownian motion, constant vol], but these shortcomings are adjusted via implied vols, typified by strike and tenor vol skew. 

If an option is underpriced, you would BUY it and delta hedge. Implicitly this means you expect future realized vol to be higher than the present option iv.

w.r.t maintaining delta neutrality, for assignment purposes, you can choose to rebalance 1) every day or 2) when total portfolio delta accumulates to an amount you are uncomfortable with [e.g. rebalance every 500 deltas]

Close out early, if you believe your target has been reached [i.e. what you think the option price should be] so that you are not exposed to further adverse moves in the market that will require hedging.

Caution though, it is Friday arvo and I've downed a few cheeky beverages


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## wayneL (2 October 2009)

Nick,

I'm interested in how the undervaluation was determined.

If it was an individual call that was underpriced relative to the rest of the chain, and in particular in relation to its corresponding put (which I doubt in these days of lightning fast arbitrage super computers), the correct risk free strategy is a "reversal". A short call/long stock combo is not risk free in any sense of the term and is not an arbitrage strategy.

A reversal consists of purchasing the underpriced call, selling the corresponding put and shorting the stock in equal size. This creates a risk free arbitrage position that never needs further hedging.

Wind up the strategy when put/call parity is restored.


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## mazzatelli (2 October 2009)

Actually Wayne is spot on

But if I remember right, that is beyond 1st yr derivatives for uni though. Back in my day we were asked to do the option + stock  portfolio as building blocks to understand risk neutral valuation for binomial pricing.

Looking at nicks point 3) of the assignment, that might be the case. I missed the part about arbitrage lol


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## wayneL (2 October 2009)

mazzatelli said:


> Looking at nicks point 3) of the assignment, that might be the case. I missed the part about arbitrage lol



Yep

The question is actually quite flawed in that sense. 

It's asking for a risk free arb, that must have risk if it is necessary to be dynamically hedged.


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## nickleeson88888 (3 October 2009)

right you are maz. we're now using volatility to identify if the call is mispriced. that is by analysing historical volatility and seeing whether current volatility is significantly different. we'll use historical prices to calculate the 'correct' volatility and if it's lower than implied volatility, then that must mean it's underpriced.

but for calculating delta N(d1), is it better to use the historical vol or implied vol?

what risk free rate would the financial review use? unsure about which one to use for this assignment. considering using the 30 day bank bill swap ref rate.
all this will affect our theoretical call price from BSM.

and where is the profit meant to come from exactly? the fact that it's not perfectly hedged? hard to get my head around this bit.


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## nickleeson88888 (3 October 2009)

one more thing,
how do you get the same call price & volatility for like several consecutive days when the financial review only states those traded above 5k and some days the option quoted from the previous day is no longer stated?


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## wayneL (3 October 2009)

nickleeson88888 said:


> right you are maz. we're now using volatility to identify if the call is mispriced. that is by analysing historical volatility and seeing whether current volatility is significantly different. we'll use historical prices to calculate the 'correct' volatility and if it's lower than implied volatility, then that must mean it's underpriced.



Nick

Of course you have to follow your course to get your degree, but in the real world, there is no definitive way of calculating over/undervaluation of options using historical volatility.

1/ What we really need to calculate this is forward volatiltiy for the life of the strategy. Unfortunately this is in the future so cannot be known. That forward realized volatility can vary significantly from the current calculated volatility.

2/ The HV figure you end up with can be highly dependent on the lookback period. 20,30,60/whatever day volatilty can all be significantly different to each other.

3/ Hence "Implied Volatility" via the current tradeable price. This is the market's forecast of forward volatility. Whether this is too high or too low is highly subjective and can only be definitively determined in retrospect.

4/ The last *traded* price in the "Fin" is a very poor representation of the current *tradeable* price and cannot be sensibly used in the real world as that last traded price may be several hours old. If the market has moved on considerably, the price quoted will be a furphy. Better to use current bid/ask if you can get it. 



> but for calculating delta N(d1), is it better to use the historical vol or implied vol?



Implied, as this is the basis for the option price.



> what risk free rate would the financial review use? unsure about which one to use for this assignment. considering using the 30 day bank bill swap ref rate.
> all this will affect our theoretical call price from BSM.



Not sure on this one in the Oz market. In the US market the 3 month treasury bill is used.



> and where is the profit meant to come from exactly? the fact that it's not perfectly hedged? hard to get my head around this bit.



If you are short gamma (long stock/short calls) you profit if theta decay and/or drops in volatility are greater that hedging losses and contest risk (commision + spread) of the hedging transactions.

If you are long gamma (short stock/long calls) profit is derived if volatility rises and profit locked in from the delta hedges are greater than losses from if vol falls and theta decay.

This is a topic all by itself that needs more than a few lines to explain properly.


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## nickleeson88888 (3 October 2009)

cheers wayneL. all valid points indeed.
are you able to tell me if it's possible to obtain a particular options price on a daily basis and its implied vol?

i've got my eyes set on WOW call options expiring on dec 2011 with a strike price of $34.00.
the day i picked this option, obviously it was in the Fin but the next day it's not so i'm wondering if there are any sources that provide historical data for aussie options? (not requiring a cost of course)

if not, can anyone with access to historical options prices post WOWs on here or PM me?
thought i'd ask for that one just in case :

if you can then i'll let you know what time period, it's not a long one


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## wayneL (3 October 2009)

Nick,

I don't trade Oz options so can't help. Getting free info is often problematic in Oz, but hopefully someone has some resources for you.

If it was US options, there are a multitude of free resources.


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## cutz (3 October 2009)

Hi Nick,

Not much action on those, WOWRU7 have an open interest of 7.

Try here http://www.morrisonsecurities.com/int_trading.htm for a webiress demo, it's got what you need, look in the options monitor window to get the quotes, course of sales for history, bring up a chart window and punch in WOWIV for an IV chart.


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## nickleeson88888 (5 October 2009)

In current market conditions, does it matter which 2 other Greeks are better to hedge against including delta? that is 3 Greeks in total. For example you should hedge against Rho in the current market if you think interest rates are going to change.
Any suggestions?


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## nickleeson88888 (5 October 2009)

cutz said:


> Hi Nick,
> 
> Not much action on those, WOWRU7 have an open interest of 7.
> 
> Try here http://www.morrisonsecurities.com/int_trading.htm for a webiress demo, it's got what you need, look in the options monitor window to get the quotes, course of sales for history, bring up a chart window and punch in WOWIV for an IV chart.




Thanks Cutz. Good site!


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## mazzatelli (7 October 2009)

nickleeson88888 said:


> In current market conditions, does it matter which 2 other Greeks are better to hedge against including delta? that is 3 Greeks in total. For example you should hedge against Rho in the current market if you think interest rates are going to change.
> Any suggestions?




Depends the $value of the Greeks involved.
You hedge to isolate your exposure is to vol. If you start to hedging everything, theres no cake to be had


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