Straddle Opportunity in Currency Options

[wayneL]

Do Your Own Research, but an opportunity highlighted by Stuart Johnston (author of Trading Options to Win [Read my review]) on another forum in British Pound currency options.

* 2.90% ?? This is a gift
SAJ - Sunday at 4:29 PM

BP December ATM straddles are selling for just 2.90% of current BPZ price. There is no way to describe this as anything other than a pure gift.

For reference, the **average** upmove in BP between now and **November** 1 is 4.67%, and upmoves > 4% have occurred 8 times in the past 14 years. The average downmove in the same period is 2.77%, with downmoves > 4% occurring 5 times in the past 14 years. Note, this is to **November 1**, with more than a month left in the life of the oppies.

BPZ is 199.34 tonight. We would rather buy the 200 Z straddles on a slight upmove Monday, but buying the 199 Z on a mild downmove is almost as good, statistically.

Net-net, the straddle purchase is historically a favourite to gain 175-300 pips, suggesting a mean ROC of something like 40% over 135 days...not counting the fact that only rarely will we hold the straddle until expiration (thus, the ROC is probably somewhat better than stated).

Good trading to all !

 

[wayneL]

Why is this a good opportunity?

British pound IVs are at rock bottom, making the options relatively very cheap. The Cheapest they've been for at least the last 2 years.

This is the 2 year IV chart:

As you can see, IV is plummeting. IVs in currency options are usually well above statistical volatilities, making them usually more of a writing proposition. <<==[edit: erroneous comment, please ignore] But the object here with the december options (which are lower gamma than the septembers) is to go long on vega as well as long gamma. If we get a nice IV lift off. This will turn into a very good trade.

Note however that there is no sign of a bottom in IV so there is a risk of further IV dumpage. However that would make them undervalued and a good reason to add.

If you wanted more gamma you could certainly go to the septembers anyway and still have plenty of vega.

Actually, all the currencies are at IV lows. Check out the Euro and Yen below (in that order)

One thing with straddles. It is best to wait till the price is sitting right on top of a strike price (in BP options 1.99 or 2.00) to be truly delta neutral.

Also futures options are primo for delta neutral straddle buying as there is negligible cost of carry priced in to the options. This makes for a very clean "either direction" opportunity.

DYOR

 

[reece55]

Why is this a good opportunity?

British pound IVs are at rock bottom, making the options relatively very cheap. The Cheapest they've been for at least the last 2 years.

This is the 2 year IV chart:

As you can see, IV is plummeting. IVs in currency options are usually well above statistical volatilities, making them usually more of a writing proposition. But the object here with the december options (which are lower gamma than the septembers) is to go long on vega as well as long gamma. If we get a nice IV lift off. This will turn into a very good trade.

Note however that there is no sign of a bottom in IV so there is a risk of further IV dumpage. However that would make them undervalued and a good reason to add.

If you wanted more gamma you could certainly go to the septembers anyway and still have plenty of vega.

Actually, all the currencies are at IV lows. Check out the Euro and Yen below (in that order)

One thing with straddles. It is best to wait till the price is sitting right on top of a strike price (in BP options 1.99 or 2.00) to be truly delta neutral.

Also futures options are primo for delta neutral straddle buying as there is negligible cost of carry priced in to the options. This makes for a very clean "either direction" opportunity.

DYOR

Very interesting Wayne, I have taken straddles on stocks, but not currency before....

Certainly the IV chart shows a clear downtrend...... I suppose however if you bought your position a fair way out, chances are it will recover in your favour....

I will do a bit of research on this one i reckon.....

Cheers

 

[wayneL]

For analysis, here is the 20, 60 & 120 day statistical volatilities. All showing that IV is at fair value.

The $64,000,000 question is if volatility will lift in the time frame or if this SOB starts trending somewhere. (both would be very nice )

With 135 days till expiry, there is plenty of time for something to happen.

 

[wayneL]

fwiw, Some further discussion from Stuart in response to a question from me:

Re: 2.90% ?? This is a gift
wayneL - Monday at 6:48 AM

SAJ

Any reason you wouldn't go for the septembers? Less time and less vega of course. But less premium at ~1.8% of BP price, and a bit more gamma to balance.

Is it because of historically likely moves in the time frame?

* Shorter term straddles
SAJ - Monday at 9:03 AM

wayne -- Well, there's (almost) always more gamma in shorter-term straddles, so that's not really a consideration, afaic.

Historically, one could buy the U straddle and have an expectation of about 100 pips profit, gross. However, given the relative calmness of the ccy mkts for the past year, it looks a bit to me as if the trader would be very well advised just now to purchase more time.

Last year, quite atypically, buying ccy straddles in the summertime turned out to be a derivative form of death by a thousand cuts: the mkts went completely dead in the water for, oh, 60 days or so. The trader (said he, raising his hand) lost 2 pips, 5 pips, 3 pips each day. Brutal.

I suppose that experience might be colouring my decision to some extent, and biasing me in favour of the Z straddle. However, the Z trade is completely consistent with my overall view of straddling, to wit, that one must allow some amount of time for the mkts to put dollars into one's pocket. Purchasing more time -- when it's dirt cheap, as now -- can hardly be a disadvantage and is very likely, historically speaking, to actually be a significant ADvantage.

There's a political kicker this year, too. In case you don't follow British politics, the plain fact is that the soon-to-be PM, Gordon Brown, is a staggering incompetent. Say what you like of Blair, and party differences aside, but Brown following Blair rates to be something of a replay of Clement Attlee following Churchill. In other words, a debacle.

Now, when exactly the debacle occurs, well, this of course I don't know. It will, though, it will. The odds seem to me to be outstandingly high that Brown, and New Labour generally, will commit some grotesque financial/economic gaffe in short order. I'm looking to be short BP in almost all the crosses for a couple of years.

The period 7 September through Christmas Day will likely tell the tale. BP is historically very strong in Oct-Dec, and if that is not the case this year, look out. I'll even give you the possible gaffe that Brown is quite capable of making right off the bat: an end run around the electorate in order to implement the new and (haha) ''improved'' EU ''constitution'' without a vote.

You heard it here first, m'friend. Moral considerations aside (can you imagine the US ''ratifying'' a new Constitution without an enormous amount of input from the electorate? I can't), this little scheme will have the immediate effect of marginalising Sterling ... forever. Right now, Sterling is and has been strong BECAUSE Britain has insisted on having what amounts to a local veto over the assorted dorks and Marxists in Brussels. Blair, out legacy-hunting, may as his final act as PM give the OK to Brussels to tear up the local veto...and Brown, I promise you, will not only acquiesce but cheer and whip this programme right along.

Might not happen. Equally, it might very well happen, and I should look for BP to drop 10-15 handles within a year of its occurrence.

Good trading to you!

 

[wayneL]

OK we've got the December contract hovering right over 1.99 right now, so lets follow how this goes. (bearing in mind this has a long time to give a profit)

The 1.99 straddle is trading at 580 ticks at the ask, so lets follow it from there.

580 ticks = USD 7,250 per straddle.

 

[wayneL]

Just for the exercise, I thought we could follow the September straddle as well.

As the September underlying futures contract trades at a slightly different value then the December, i had to wait till the price was over the top of a strike. Earlier on, we had Sept futures at 2.00 with the Straddle at 366 ticks.

So now we have:

December straddle bought for 580 ticks = USD 7,250 per straddle.
September straddle bought for 366 ticks = USD 4,575 per straddle.

The September has more Gamma, less Vega and More Theta (though at the moment, not a lot of difference) than the December.

If we get a strong move *soon*, the September will outperform.

If it lingers for any great length of time, there will come a point where we start getting eaten alive in the Septembers.

Chart:

 

[wayneL]

While we're following the currency straddles (both of which are about 10 ticks in profit at the bid) there is another low IV situation in Gold the I mentioned here: http://sigmaoptions.blogspot.com/2007/07/look-at-metals-volatilities.html

It's just another straddle opportunity we can follow here. With October Gold trading at $662 we can buy the straddle at $36.20 at the bid.

362 ticks = USD 3,620 per straddle.

Stay tuned

While we're following the currency straddles (both of which are about 10 ticks in profit at the bid) there is another low IV situation in Gold the I mentioned here: http://sigmaoptions.blogspot.com/2007/07/look-at-metals-volatilities.html

It's just another straddle opportunity we can follow here. With October Gold trading at $662 we can buy the straddle at $36.20 at the bid.

362 ticks = USD 3,620 per straddle.

Stay tuned

The gold straddle is about 20 ticks down due to a slight drop in IV. Price has not moved enough to get any sort of delta yet.

 

[wayneL]

Update:

Both of these straddle are about 60 ticks in profit.

With any further moves up in the GBP, the greater gamma of the Nov straddle will really start to tell.

 

[bingk6]

Update:

With any further moves up in the GBP, the greater gamma of the Nov straddle will really start to tell.

Wayne,

I think you meant the Sept Straddle?

Secondly, are there any reasons why a currency straddle may be preferable to a stock straddle. My rational is that whenever we get a significant squeeze in the IVs, that the setup is good for straddles, irrespective of whether they are for stocks or currency.

 

[wayneL]

Wayne,

I think you meant the Sept Straddle?

Yes, sorry, SEPT straddle.

Secondly, are there any reasons why a currency straddle may be preferable to a stock straddle. My rational is that whenever we get a significant squeeze in the IVs, that the setup is good for straddles, irrespective of whether they are for stocks or currency.

None at all. I just highlighted this one because Stuart Johnston did... and if it went t1ts up I could blame him.

A squeeze in IVs is a good time to put on a straddle IF we think that there will be a return to higher IV's via a volatile move... or at least a trend in one direction or the other. IV's (and indeed realized volatility) can stay low for extended periods. You are delta neutral, but you are long gamma and vega and short theta.

That is the premise of this trade, according to Stuies seasonal database at www.timeandtiming.com is that historically the pound DOES normally move significantly in the time frame indicated.

 

[Hopeful]

Are the graphs made with Hoadley's? How did you manage that? And how's it going with the trades now? Thanks for posting. I just noticed this thread, so has IV already moved? If not I might jump in while the water is still warm (if).

 

[wayneL]

Are the graphs made with Hoadley's? How did you manage that? And how's it going with the trades now? Thanks for posting. I just noticed this thread, so has IV already moved? If not I might jump in while the water is still warm (if).

It's about 50 ticks in profit as of Fridays close. IV has risen a bit but still low. Whether it's still a good trade. As long as it's truly delta neutral i.e. right on top of a strike, it probably still is... but DYOR FFS!

Stat vol charts are from esignal and IV charts are.... ummm.... well that's a secret. To many hits on those and they might block it. But here's an update:

 

[wayneL]

So now we have:

December straddle bought for 580 ticks = USD 7,250 per straddle.
September straddle bought for 366 ticks = USD 4,575 per straddle.

The September has more Gamma, less Vega and More Theta (though at the moment, not a lot of difference) than the December.

If we get a strong move *soon*, the September will outperform.

If it lingers for any great length of time, there will come a point where we start getting eaten alive in the Septembers.

Chart:

Update:

As of right now, the price at the bid for these two straddles are

Dec => 700 ticks, an open profit of 140 ticks = $893.75
Sept=> 499 ticks, an open profit of 167 ticks = $1043.75

So the higher gamma is starting to tell in the Sept straddle. When viewed as a % of investment, the sept looks even better.

Dec => 12.3%
Sept => 22.8%

Our gold straddle however, is down ~$600 due to lack of movement and a further decline in IV + a little bit of theta. Still plenty of time up our sleeve though.