Options Mentoring

[Fox]

For a visual look at it, enter a long straddle or strangle (or even a wrangle) into Hoadley in a back month. Copy that to the comparison table and then alter IV up or down in one of them. (I think I used to enter IV manually with copy & paste rather than use the Hoadley button which changes IV for both.) You will get a very clear picture of what IV does to the trade.

Did the visual comparison of falling IV for various back month wrangles using Hoadley. The results really do speak for themselves.

I re-read Cottle's chapter on the greeks (in particular, vega) and had a much better understanding this time. He describes back months as more of a "vega play", whereas front months are more of "theta vs gamma play".

It can be a good strategy when IV is typically fairly low after the market has been travelling up for some time and is likely to spike up a bit should the market fall.

Sigh! It's all about vol at the end of the day. If I only knew the secret to predicting vol . Good to know of some predictable vol patterns like the one you described above. I think that it would be useful to start a thread on common vol patterns.

 

[Grinder]

I re-read Cottle's chapter on the greeks (in particular, vega) and had a much better understanding this time. He describes back months as more of a "vega play", whereas front months are more of "theta vs gamma play".

This is pretty much how I see it also, when used for hedging purposes I prefer using same month or front month in most cases, the gamma can still come to the rescue if required. I try not too add too many back months if I don't have to unless it looks attractive to do so, vega is one less thing I would then need to worry about.

Sigh! It's all about vol at the end of the day. If I only knew the secret to predicting vol . Good to know of some predictable vol patterns like the one you described above. I think that it would be useful to start a thread on common vol patterns.

Good thread idea. Vol patterns don't always stay true to form though I see pedicting vol as less forgiving then direction, am still rubbish at predicting it but close enough is good enough sometimes.

 

[cutz]

Quick question here guy's,

Does anyone juggle flys to expiry or is it a lost cause.

Say it's sitting right on centre strike today with 4 working days to go, positive theta is kicking along, is it worth experimenting?

 

[sails]

Quick question here guy's,

Does anyone juggle flys to expiry or is it a lost cause.

Say it's sitting right on centre strike today with 4 working days to go, positive theta is kicking along, is it worth experimenting?

Yeah - it's a difficult decision!

Because markets don't stand still, there is a good chance it will move away in the next 4 trading days. My own rule is to exit if the centre strike is hit close to expiry as probability favours a move away and with negative gamma starting to kick in, it won't take much to hurt the position.

It is tempting to hang on and hope because there is still a fair bit of theta in the atm sold strikes... lol

In situations like this, it's often good to ask yourself - would you initiate that same fly now if you had no position at all? Would it be an acceptable risk/reward? If the answer is no - then that's probably your answer to close it and bank your profits.

If the longs have practically no value, you could consider only closing the shorts and leave the almost worthless longs as lottery tickets going into expiry. It may not even be worth fees to close the longs anyway and if the market does cross your long strike, gamma will be your best friend!

And Fridays - often MMs wind volatility down by Friday afternoon - can sometimes be a good time to do any buying. I have often found IVs are actually higher on the following Monday morning. Not guaranteed and can depend on other influencing factors (eg earnings, divs, etc). If our local MMs read this, it probably won't work for a while to confuse the issue...

If you do end up with a long option ITM on the XJO, I believe you have to request exercise at expiry. I don't think it's automatic - will try to find the article in the ASX site. I'm not sure how this works with IB as I had a long ITM XJO option in the demo and it didn't show up in the exercise window.

Do you know how IB handle ITM long index options at expiry, Cutz?

EDIT - can't find the article I'm looking for on the ASX site. I think it was it one of their newsletters that explained that there is no automatic exercise for ITM long index options and that the holder will have to request exercise.
While looking for the above - I found this link which confirms that MMs hedge XJO options with the SPI. http://www.asx.com.au/products/pdf/index_options.pdf

 

[cutz]

Thanks heaps Sails for knocking some sense into me.

Very tempting to hang on but your idea of closing out the shorts seems like the best option.

Some time ago i had short XJO's expire just ITM , outbound cash settlement occurred, i assume the opposite will be true with a long ITM with inbound auto cash settlement occurring.

I've never had the pleasure of a long expiring ITM.

 

[sails]

Hi Cutz,

Without a crystal ball, we won't know if that is the best decision until Thursday next week. Personally, I don't like atm shorts so to expiry due to escalating negative gamma.

If I'm trading into expiry, I actually prefer to be long in the last few days IF conditions are favourable. Gamma easily outruns theta in a fast move. Don't know about index options, but BHP was the one I used to watch mostly for signs of a potential strong move into expiry. Have long had an interest in maximum pain theory and expiry in general. Probably attracted by the low risk/high reward nature of the trades. It's not the ultimate strategy by any means, but is simply another string to the bow for me when actively trading!

EDIT - an after thought with the longs. If they really are worthless, I would leave them especially if brokerage will cost more than what I would get back on selling them. However, if there is some decent value in them, it's probably better to bank the money. Again, ask the question - would you initiate a strangle at those strikes and at that price so close to expiry.

 

[cutz]

Hi Sails,

Lots to consider,

After much deliberation i may play this out a little longer, just want to see if i can land a small fly into expiry.

Got a funny feeling this could the first and last time i'll try this.

Long gamma in Jan if things go pear shaped.

 

[Fox]

Hi all,

If the longs have practically no value, you could consider only closing the shorts and leave the almost worthless longs as lottery tickets going into expiry.

I've experienced one occasion where I tried closing the short and leaving the worthless long as a lottery ticket. I found that my order to close the short was not being filled. I then changed my order form closing a short to closing a vertical (ie. both my WOTM long and short legs) and it was filled with a much more favourable price.

Cottle does say that MMs prefer "flat" trades. I presume by "flat", he means a short paired with a long, as it is limited risk. I suspect that was why I had a better fill when closing a vertical instead of an outright short.

Personally, I was happy with that trade because the lottery tickets were just that ... a long shot. It was not my intention to purchase this wager. It was more of a wager by default. I was happier to have more money in the bank than having a punt with long shot bet.

And Fridays - often MMs wind volatility down by Friday afternoon - can sometimes be a good time to do any buying.

I must keep that in mind. Unfortunately, I sold a wing earlier today without the benefit of your tip.

 

[sails]

Hi all,


I've experienced one occasion where I tried closing the short and leaving the worthless long as a lottery ticket. I found that my order to close the short was not being filled. I then changed my order form closing a short to closing a vertical (ie. both my WOTM long and short legs) and it was filled with a much more favourable price.

Cottle does say that MMs prefer "flat" trades. I presume by "flat", he means a short paired with a long, as it is limited risk. I suspect that was why I had a better fill when closing a vertical instead of an outright short.

Personally, I was happy with that trade because the lottery tickets were just that ... a long shot. It was not my intention to purchase this wager. It was more of a wager by default. I was happier to have more money in the bank than having a punt with long shot bet.

I agree. If you can get a better price by trading the spread, then that's the way to go. Lottery tickets should be cheap - extremely cheap. If they are down to half a cent, it will cost money to close them - even with IB's brokerage rates, so in that case it's smarter to leave them there. Also, if the longs are that cheap, chances are it won't help to get a better price on the shorts.

If the the shorts are ATM and front month (as Cutz described today) - they are usually the most liquid and it can sometimes be possible to get a reasonable price without trading the spread.

Just some food for thought...

I must keep that in mind. Unfortunately, I sold a wing earlier today without the benefit of your tip.

It's definitely not guaranteed! Be interesting to check it out on Monday to see how it compares. If the markets are up on Monday with an accompanying drop in IV, it might have put you in front today with the market down a bit.

 

[mazzatelli]

Does anyone juggle flys to expiry or is it a lost cause.

Say it's sitting right on centre strike today with 4 working days to go, positive theta is kicking along, is it worth experimenting?

It's been a while...
I have a model for short term stat vol, so holding depends on the output.
PnL is still path dependent

 

[cutz]

Hi Mazza,

Ended up cutting the trade at 3 working days to go. It was still looking alright, consolidation at around 4700 but I couldn't handle the excitement, threat of a gamma runaway looked pretty menacing.

 

[Fox]

Help! I've just had the wind knocked out of my sails.

I was piloting my XJO low prob IC nicely for the past fortnight. I watched the IV fall gently as XJO traded nicely within a tight range. Theta was fattening my IC nicely. My thoughts were on exiting soon and celebrating Christmas on a high.

24 hours is a long time in politics, they say. Add options to that list as well. Today I woke to find XJO crash a steep 3%. Being delta neutral, I was able to handle the delta generated. But IV rose a whopping 4% as well, sinking my IC into further despair. A sharp rise in IV was something I did not handle well.

Expiry is 20 calendar days away. I have adjusted my IC ie. locked in a loss and got myself delta neutral again. My current plan is to wait for IV to settle lower and exit with a small loss/profit. I figure that 20 days will give XJO enough time to settle and for IV to go lower. Will that be wishful thinking? If not, what would be a prudent thing to do now?

To prevent a future mishap like this, I am contemplating this plan. If I find my low prob IC to be moderately profitable and IV is low, add a long vega spread (a calender or back month wrangle?) to get myself vega neutral. I view this as a way to lock in my profits against adverse IV moves. Any comments about this sort of approach? Good, bad, ugly?

Falling spot prices and rising IV seem to go hand in hand. Any general advice on mitigating the double whammy effects of a spiking IV and falling spot price on a fly or low prob IC would much appreciated.

 

[mazzatelli]

1 adjustment locked in a loss?
If that is the case, it is highly likely your r:r is poor for any hedging to be effective

 

[cutz]

Hi Fox,

Not sure how Monday will pan out but one idea for XJO is to put on a short fly in a backmonth centered around todays action, maybe even without the short lower strike giving you a backspread.

Of course this all depends on what happens overnight and you outlook on the index, if IV kicks up further, negative theta will be nasty.

Just an idea, still learning myself so hopefully one of the pros can be more helpful.

 

[Fox]

1 adjustment locked in a loss?

Not quite 1 adjustment. I have made multiple adjustments prior to today's > 2 sigma downward move in XJO. I had suffered some small losses from over adjustments in the last fortnight. I also locked in some losses from the previous dip in XJO at the end of Oct. Today's daily move was the largest for a long time (last five months according to The Age). Basically, I've just managed to get my IC profitable again when today's events wiped out my gains.

Of course this all depends on what happens overnight and you outlook on the index ...

Thanks for your suggestion Cutz. Not quite sure about the outlook. Read some reports that the Dubai situation is a storm in a tea cup. I guess everyone takes their lead from the US. So, we'll have to see how US closes the week. The SPI has improved slightly as I type this.

 

[Fox]

After thinking about what Mazza and Cutz said, it would seem that some form of back month wing (eg. Cutz's backspread suggestion) is the way to go, when handling sharp price falls and sharp IV increases. Especially after a fall in in recent IV.

For a start, additional wings should improve my r:r ratio ie. taming gamma. Back month wings on the put side of my IC acts as a natural defence against a sharp price fall/sharp IV rise combo. Perhaps this is what Grinder refers to as "built-in protection"?

I'm not sure about a back month wing on the call side of my IC. Price rises tend to be accompanied by a fall in IV and therefore a back month call wing might not be such a good idea. I will need to play with Hoadley to have a feel for this, and to see where the tradeoffs are. I'm sure theta will suffer to some degree. Hopefully not too much.

Thanks guys for your ideas.

 

[mazzatelli]

Depending on how much unrealized profit is available to be booked, it may be more prudent to simply offset the position.

vega &/or gamma risk can often overpower theta - which is why I prefer to trade with a bias in vol &/or direction. Nothing more frustrating than seeing a position accumulate theta gains, only to be negated by v/g on any particular day.

Each to their own...

 

[Fox]

Depending on how much unrealized profit is available to be booked, it may be more prudent to simply offset the position.

Hi Mazza, I notice that you use the term offset, which I am not too clear on. By offset, am I correct to assume that this means taking some profit off your position and reducing your risk? Eg. harvesting an embedded fly from a pregnant butterfly?

vega &/or gamma risk can often overpower theta - which is why I prefer to trade with a bias in vol &/or direction. Nothing more frustrating than seeing a position accumulate theta gains, only to be negated by v/g on any particular day.

Hear, hear. That, I now finally understand.

 

[Grinder]

After thinking about what Mazza and Cutz said, it would seem that some form of back month wing (eg. Cutz's backspread suggestion) is the way to go, when handling sharp price falls and sharp IV increases. Especially after a fall in in recent IV.

For a start, additional wings should improve my r:r ratio ie. taming gamma. Back month wings on the put side of my IC acts as a natural defence against a sharp price fall/sharp IV rise combo. Perhaps this is what Grinder refers to as "built-in protection"?

I'm not sure about a back month wing on the call side of my IC. Price rises tend to be accompanied by a fall in IV and therefore a back month call wing might not be such a good idea. I will need to play with Hoadley to have a feel for this, and to see where the tradeoffs are. I'm sure theta will suffer to some degree. Hopefully not too much.

Thanks guys for your ideas.

Now were cooking with gas.. it's these situations that I'm glad to have my built in protection (a position that it is constructed upon the opening of an IC or thereabouts) that could be anything from a kite spread (aptly named by the rookies guru Mark Wolfinger) to a debit spread in a back month that is half the size of the IC or perhaps a DD or calander etc.. anything that has opposing greeks to offset the risk. Having some of these as stand alone positions or as added protection goes along way reducing the need for a quick adjustment and can also create profit on their own, it's all a trade off though.

Like mazza says about vol, all depends on your view. Really knowing the greeks puts it all into perspective, the trade off between gamma & theta, the effect vega will have etc.. Whereas the strategies above are just tools that can be used to combat one over the other.

A rule of thumb for me fox is, if I can offset risk over locking in a loss I will.

hope some of this helps, sounds like your on the right track.

 

[cutz]

Hi guys,

I was after an opinion on managing an iron fly.

Is there anything fundamentally wrong with rolling up/down one side (generating credit) and pulling short positions off the other side to keep delta in check, what you end up with is crossed short strikes and a messy looking position.

Does anyone consider this to be an acceptable practice as an alternative to using spot.