Monday, January 03, 2005
Trader tax expert reference?
John (or others),
I've just recently started trading full-time for my own account. I'm trading a in a JBO and am getting professional trader status with mark-to-market accounting.
My question: can someone direct me to a tax expert so i can do the proper paperwork and filing with the IRS to ensure my trader status?
thanks,
michael
I've just recently started trading full-time for my own account. I'm trading a in a JBO and am getting professional trader status with mark-to-market accounting.
My question: can someone direct me to a tax expert so i can do the proper paperwork and filing with the IRS to ensure my trader status?
thanks,
michael
Saturday, September 25, 2004
Back to business as usual
Opening position:
Long QQQ Nov 34P (10X)
Long QQQ (2.75X)
A good week for scalping (a poor week for blogging though). Had a lot of two way action that allowed me to scalp another $190 on my position this week. Here's what my position currently looks like after the close on Friday.
I've spent a lot of time working on some volatility studies on the QQQ's this week and hope to be reporting some of my insights over the next few days.
Overall volatility has contracted on the QQQ's further but the intraday movement has been quite substantial - usually a harbinger of future expansion on the daily closing SV. Right now I've been trying to scalp at the $0.20 to $0.25 level which is just about .8 standard deviations. With the SV contracting my general high/low targets are +/- .25 points on the index.
Closing position:
Long QQQ Nov 34P (10X)
Long QQQ (4.75X)
Long QQQ Nov 34P (10X)
Long QQQ (2.75X)
A good week for scalping (a poor week for blogging though). Had a lot of two way action that allowed me to scalp another $190 on my position this week. Here's what my position currently looks like after the close on Friday.
I've spent a lot of time working on some volatility studies on the QQQ's this week and hope to be reporting some of my insights over the next few days.
Overall volatility has contracted on the QQQ's further but the intraday movement has been quite substantial - usually a harbinger of future expansion on the daily closing SV. Right now I've been trying to scalp at the $0.20 to $0.25 level which is just about .8 standard deviations. With the SV contracting my general high/low targets are +/- .25 points on the index.
Closing position:
Long QQQ Nov 34P (10X)
Long QQQ (4.75X)
Sunday, September 19, 2004
Anatomy of a trade
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (2.75X)
With all my trades I try to make my decision process concrete. I focus on clearly describing my reasons for opening a position, defining my expectations and setting my absolute risks. As the trade progresses, at key intervals, I determine which actions I need to take. I then assess how well I've managed to adhere to my plans.
I'd like to think I treat trading as a business. By that I mean that I have a defined business model, operational controls and cash flow or budget forecast. I measure and take precautions against undue risk and catastrophic loss. I study what my competition is doing. I adapt to changing market conditions. And I have a defined exit strategy.
With these processes in mind let's examine my SEP QQQ straddle.
I bought the SEP 33 at the money straddle with just over six weeks until expiration. I paid $2.35 for the straddle which at the time was about 21% implied volatility. I selected this level of IV due to some analysis of both historic volatility ranges (21% is on the low end) and my current measures of intraday volatility which I pegged at near 30%. I figured, based on my experience, that volatility over the life of the position had a good chance of rising on a close to close basis and remaining steady or improving on an intraday basis. I figured that if I was wrong the worst that would happen through actively trading the position delta neutral would be a max downside of about a 14% actual vol. - which would translate into around a fifty percent loss on my initial investment of about $960. My upside was to trade the position at 30% vol or better which would put my risk reward at nearly 1:1. My previous success rate with this kind of trade is about 60% winners so my true net expectation was about $100 gain or just under 10% for the trade.
You can follow the day to day decisions I made by reading the archives. My net on the trade amounted to a $384 or 40% loss.
Why the loss? First, I guessed wrong on volatility. Actual vol over the period came closer to about 19% which explains about $100 or a quarter of my losses. The rest can be attributed to poor scalping decisions and significant directional movement in the underlying index. In effect I oversold my deltas early on when the QQQ crossed above 34. And I held on to this "bearish conviction" for the duration. That mistake cost me another $150 leaving about $130 in losses that were extrinsic to my decisions.
By adjusting delta neutral in an uptrending market I failed to let my gains run. But this is an rare but expected factor in the long run. If the market had zigzagged around unchanged - like it is apt to do much of the time - this final $130 loss would have been non-existent. Them's the breaks when looking at a single trade in isolation from a history of transactions.
Lesson learned: Delta neutral trading is a skill that must constantly be improved upon. To find the "natural" hedging threshold is the most daunting task whether you are long or short gamma. When long, if volatility is at the low end of its historic range its better to adjust frequently. The trouble is that you need to have enough size to drive the commissions (i.e. cost of operations) to near zero. I may have had too small of a position (4 straddles) to overcome the commission impact (I spent over $80 for all my adjustments). So I learned that I need to set my adjustment levels based on a smaller standard deviation move - I mostly used 1 standard deviation or greater to adjust. Probably a third or a half stan. dev. could have improved performance as it would have caught more sideways action. Obviously overtrading my deltas should have been avoided as well.
It may be interesting to note that if I had done nothing to adjust the position since day one I would have broken about even on the trade. The index closed at 35.43 on Friday (8 cents above my straddle purchase cost). But this, while a bit embarrassing, does not sway me from the delta neutral approach. In effect the index traded at 19% actual vol after I entered the trade. It was more likely that the QQQ index would end up at 33 than end where it did. Buy and hold is generally a disaster when it comes to options - or at best a zero expectation game.
On a positive note, I scalped another $0.25 on 100 QQQon Friday against my NOV puts. I'm now up about $170 (on an initial cost of $1060). Looked at from a volatility perspective, I've reduced my original cost of 23.5% IV down to 17.5% currently. In a 19% environment I can expect this trade to be a winner. If we get some uncertainty in the next two months, the prospects for success are even brighter.
One standard deviation high/low QQQ targets for Monday are: 35.73 & 35.07. I'll continue to try to scalp at moves of $0.25 to $0.30 which is just around .75 standard deviations here.
Closing position:
Long QQQ Nov 34P (10X)
Long QQQ (2.75X)
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (2.75X)
With all my trades I try to make my decision process concrete. I focus on clearly describing my reasons for opening a position, defining my expectations and setting my absolute risks. As the trade progresses, at key intervals, I determine which actions I need to take. I then assess how well I've managed to adhere to my plans.
I'd like to think I treat trading as a business. By that I mean that I have a defined business model, operational controls and cash flow or budget forecast. I measure and take precautions against undue risk and catastrophic loss. I study what my competition is doing. I adapt to changing market conditions. And I have a defined exit strategy.
With these processes in mind let's examine my SEP QQQ straddle.
I bought the SEP 33 at the money straddle with just over six weeks until expiration. I paid $2.35 for the straddle which at the time was about 21% implied volatility. I selected this level of IV due to some analysis of both historic volatility ranges (21% is on the low end) and my current measures of intraday volatility which I pegged at near 30%. I figured, based on my experience, that volatility over the life of the position had a good chance of rising on a close to close basis and remaining steady or improving on an intraday basis. I figured that if I was wrong the worst that would happen through actively trading the position delta neutral would be a max downside of about a 14% actual vol. - which would translate into around a fifty percent loss on my initial investment of about $960. My upside was to trade the position at 30% vol or better which would put my risk reward at nearly 1:1. My previous success rate with this kind of trade is about 60% winners so my true net expectation was about $100 gain or just under 10% for the trade.
You can follow the day to day decisions I made by reading the archives. My net on the trade amounted to a $384 or 40% loss.
Why the loss? First, I guessed wrong on volatility. Actual vol over the period came closer to about 19% which explains about $100 or a quarter of my losses. The rest can be attributed to poor scalping decisions and significant directional movement in the underlying index. In effect I oversold my deltas early on when the QQQ crossed above 34. And I held on to this "bearish conviction" for the duration. That mistake cost me another $150 leaving about $130 in losses that were extrinsic to my decisions.
By adjusting delta neutral in an uptrending market I failed to let my gains run. But this is an rare but expected factor in the long run. If the market had zigzagged around unchanged - like it is apt to do much of the time - this final $130 loss would have been non-existent. Them's the breaks when looking at a single trade in isolation from a history of transactions.
Lesson learned: Delta neutral trading is a skill that must constantly be improved upon. To find the "natural" hedging threshold is the most daunting task whether you are long or short gamma. When long, if volatility is at the low end of its historic range its better to adjust frequently. The trouble is that you need to have enough size to drive the commissions (i.e. cost of operations) to near zero. I may have had too small of a position (4 straddles) to overcome the commission impact (I spent over $80 for all my adjustments). So I learned that I need to set my adjustment levels based on a smaller standard deviation move - I mostly used 1 standard deviation or greater to adjust. Probably a third or a half stan. dev. could have improved performance as it would have caught more sideways action. Obviously overtrading my deltas should have been avoided as well.
It may be interesting to note that if I had done nothing to adjust the position since day one I would have broken about even on the trade. The index closed at 35.43 on Friday (8 cents above my straddle purchase cost). But this, while a bit embarrassing, does not sway me from the delta neutral approach. In effect the index traded at 19% actual vol after I entered the trade. It was more likely that the QQQ index would end up at 33 than end where it did. Buy and hold is generally a disaster when it comes to options - or at best a zero expectation game.
On a positive note, I scalped another $0.25 on 100 QQQon Friday against my NOV puts. I'm now up about $170 (on an initial cost of $1060). Looked at from a volatility perspective, I've reduced my original cost of 23.5% IV down to 17.5% currently. In a 19% environment I can expect this trade to be a winner. If we get some uncertainty in the next two months, the prospects for success are even brighter.
One standard deviation high/low QQQ targets for Monday are: 35.73 & 35.07. I'll continue to try to scalp at moves of $0.25 to $0.30 which is just around .75 standard deviations here.
Closing position:
Long QQQ Nov 34P (10X)
Long QQQ (2.75X)
Friday, September 17, 2004
When to scalp
Opening position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (2.75X)
A little wiggle to the upside, allowed to me to sell at my target high (sold 100 QQQ at 35.55) which I later bought back at the unchanged level (bought 100 QQQ at 34.25). Heading into expiration Friday (and a triple witching one at that) short and looking for one more day of volatility.
The most difficult aspect of trading delta neutral is deciding when to scalp your position. If you're short, you want to sit tight and ride out the minor turbulence. When you're long, all that intraday noise is music to your ears. I've spent a long time both studying markets and living with positions trying to gauge the most effective hedging levels. Here's a few things I've learned...
High/low stan. dev. targets for the day: 35.58 & 34.92.
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (2.75X)
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (2.75X)
A little wiggle to the upside, allowed to me to sell at my target high (sold 100 QQQ at 35.55) which I later bought back at the unchanged level (bought 100 QQQ at 34.25). Heading into expiration Friday (and a triple witching one at that) short and looking for one more day of volatility.
The most difficult aspect of trading delta neutral is deciding when to scalp your position. If you're short, you want to sit tight and ride out the minor turbulence. When you're long, all that intraday noise is music to your ears. I've spent a long time both studying markets and living with positions trying to gauge the most effective hedging levels. Here's a few things I've learned...
- Option profits exist because the volatility you buy is lower than the volatility you sell.
- When trading delta neutral, this means the ensuing actual volatility must be greater than the implied volatility of your initial purchase (or vice versa if you open short gamma).
- From the long side, that means you need to see intraday movement that far exceeds the SV of closing prices.
- The purest way to measure this intraday movement is to amass intraday tick-by-tick trade data and calculate an SV from there. I've rarely done this (the closest I've come is a long analysis on 5-minute intervals in a few stocks), but instead use intraday high /low data as a surrogate to gauge my volatility targets (that's the point of my target prices I give every day at the end of my blog entry).
- When trading your gamma, you can place orders based either on your actual deltas or based on price levels implied by volatility targets. I stick to volatility targets.
- By "volatility target" I mean some multiple of the daily targeted price movement. Example: with the QQQ at 35 and a target volatility of 25%, the one standard deviation expected price move equals about +/- $0.55 [35*.25/SQRT(252)].
- That's the "science" of selecting a trading level. The "art" is determining if you should trade at 1/2 standard deviation, a whole deviation or some other multiple. I try to use this rule of thumb: when vol is at the relatively low end of its historic range, trade at some multiple less than a full standard deviation; when vol is at the high end of the range, trade at a multiple greater than one standard deviation. This basically "let's profits run" in a wild environment and cashes in quickly on quiet days.
- If you're short gamma always trade at a multiple of two or more standard deviations.
- One other short gamma technique is to trade on a time interval basis: once a day, once every three days, whatever. At the appointed time, get flat your deltas. The point is to discipline your in and out points by waiting out the wiggles. It takes nerves of steel to sit tight and maintain the discipline.
- Finally, the success of delta neutral trading is a function of your transaction costs and position size. If you need to trade at 1/4 intervals but your position is so small that a quarter point move equates to less than a hundred deltas, commissions will eat you alive.
*****
One last day on the SEP position. If we go below 35 I'll try to exit the butterfly (and the whole of my SEP position) for some profit. Otherwise, I'm focused on trading out the gamma on my NOV puts.
High/low stan. dev. targets for the day: 35.58 & 34.92.
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (2.75X)
Wednesday, September 15, 2004
Some welcome selling
Opening position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (.75X)
Gap down open. A nice little sell off today which allowed me to buy in some of my shorts from recent trading. I bought 200 QQQ at 35.10 (caught the low!) and rang the cash register a little. The butterfly is still lifeless but at least the NOV puts are behaving. If we rally tomorrow I have some fresh ammunition to let 'em have it again. If we drop some more, I'll scoop a little additional change. (Just don't sit there, please!)
Still short about 200 deltas. High low targets for Thursday: 35.55 & 34.89.
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (2.75X)
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (.75X)
Gap down open. A nice little sell off today which allowed me to buy in some of my shorts from recent trading. I bought 200 QQQ at 35.10 (caught the low!) and rang the cash register a little. The butterfly is still lifeless but at least the NOV puts are behaving. If we rally tomorrow I have some fresh ammunition to let 'em have it again. If we drop some more, I'll scoop a little additional change. (Just don't sit there, please!)
Still short about 200 deltas. High low targets for Thursday: 35.55 & 34.89.
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (2.75X)
Yawner
Opening position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (.75X)
Quiet day. Tight range. Basically unch'd at close. No changes to position. No change in the game plan. Calm before the storm?
Here's what my position looks like heading into expiration:
...any questions on where I want this one to go?
High/low for tomorrow: 35.92 & 35.25
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (.75X)
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (.75X)
Quiet day. Tight range. Basically unch'd at close. No changes to position. No change in the game plan. Calm before the storm?
Here's what my position looks like heading into expiration:
...any questions on where I want this one to go?
High/low for tomorrow: 35.92 & 35.25
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (.75X)
Monday, September 13, 2004
Emptying the well
Opening position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (1.75X)
The rally continues and I continue to fight the trend. At least I waited until the market made a two standard deviation move up (at 35.69). I unloaded my stray 35 call and then sold another 100 QQQ at that point. I've reached my three sells personal limit on my gamma (i.e. I'll sell my deltas three times in a row and then let the position drift higher with no adjustments for a few days). This gets me short in a big way for this size position: I'm short about 330 deltas going into the expiration.
My butterfly is worthless at this point unless we move back below 35. So the net on the original position is -$383. I've written that one off and I'm now playing my NOV puts as a straight delta neutral play. I've only managed some very minor scalps on that position so I need some retracement here to put some money in the till. Lots of time on this one but it's never too soon to worry. I'll put some buy orders GTC down way below and basically take a mental vacation here. I've got some stops on the butterfly if we trade back below 34.50 as well.
I'll start thinking about my post mortem on the SEP trade and try to give a decent wrap up on it by Friday.
One standard deviation high/low for tomorrow: 35.96 & 35.20.
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (.75X)
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (1.75X)
The rally continues and I continue to fight the trend. At least I waited until the market made a two standard deviation move up (at 35.69). I unloaded my stray 35 call and then sold another 100 QQQ at that point. I've reached my three sells personal limit on my gamma (i.e. I'll sell my deltas three times in a row and then let the position drift higher with no adjustments for a few days). This gets me short in a big way for this size position: I'm short about 330 deltas going into the expiration.
My butterfly is worthless at this point unless we move back below 35. So the net on the original position is -$383. I've written that one off and I'm now playing my NOV puts as a straight delta neutral play. I've only managed some very minor scalps on that position so I need some retracement here to put some money in the till. Lots of time on this one but it's never too soon to worry. I'll put some buy orders GTC down way below and basically take a mental vacation here. I've got some stops on the butterfly if we trade back below 34.50 as well.
I'll start thinking about my post mortem on the SEP trade and try to give a decent wrap up on it by Friday.
One standard deviation high/low for tomorrow: 35.96 & 35.20.
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (.75X)
Sunday, September 12, 2004
Continued follow through
Opening position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (3.75X)
Another one of those straight up days on Friday. I sold 100 QQQ at 34.85 and a second 100 QQQ at 35.15. The position has got me leaning short just over two hundred deltas using my modified position. This "lean" plus my gamma puts me flat if the upward drift continues on Monday and gives me some very decent cash if we reverse.
I'll be looking to sell some more stock at the 35.50-60 area and will cover incrementally at 34.80 and 34.50 down below. My high/low targets for Monday are: 35.40 & 34.75.
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (1.75X)
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (3.75X)
Another one of those straight up days on Friday. I sold 100 QQQ at 34.85 and a second 100 QQQ at 35.15. The position has got me leaning short just over two hundred deltas using my modified position. This "lean" plus my gamma puts me flat if the upward drift continues on Monday and gives me some very decent cash if we reverse.
I'll be looking to sell some more stock at the 35.50-60 area and will cover incrementally at 34.80 and 34.50 down below. My high/low targets for Monday are: 35.40 & 34.75.
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (1.75X)
Friday, September 10, 2004
Two bits and then some...
Opening position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (3.75X)
Not a lot to say today. Trying to scalp 40 to 50 cents per day on this position. Got a round trip today as I bought 100 QQQ at 34.20 and sold those shares out at 34.65. Still using my modified gamma as discussed yesterday. If the market continues to meander, I should pick up some nice change here and there. It's almost mechanical as I put limit buys and sells about $0.25 apart trying to stay flat. If for some reason the market runs I'll back off for a while and try not to cover too much too soon. Usually if I get three fills in one direction, I'll lay off for a day or so and see what follow through is like. But until then, I'll take what I'm given.
I'll continue to trade the stock even though I've got some decay due with the weekend. An alternate plan may be to sell out my SEP 35 premium if we hover around 35 tomorrow and the price seems reasonable.
High/low one standard deviation targets for Friday: 34.87 & 34.22
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (3.75X)
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (3.75X)
Not a lot to say today. Trying to scalp 40 to 50 cents per day on this position. Got a round trip today as I bought 100 QQQ at 34.20 and sold those shares out at 34.65. Still using my modified gamma as discussed yesterday. If the market continues to meander, I should pick up some nice change here and there. It's almost mechanical as I put limit buys and sells about $0.25 apart trying to stay flat. If for some reason the market runs I'll back off for a while and try not to cover too much too soon. Usually if I get three fills in one direction, I'll lay off for a day or so and see what follow through is like. But until then, I'll take what I'm given.
I'll continue to trade the stock even though I've got some decay due with the weekend. An alternate plan may be to sell out my SEP 35 premium if we hover around 35 tomorrow and the price seems reasonable.
High/low one standard deviation targets for Friday: 34.87 & 34.22
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (3.75X)
Thursday, September 09, 2004
Scalping like a pro(?)
Opening position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (4.75X)
A relatively quiet day but one with some two way action - just what you need when you're long gamma. I tried to take some advantage of the situation. With the morning spike up, I sold a hundred QQQ (at 34.60) against my NOV position. Right now I'm trying to get as much juice out of my gamma as possible. So I look at my position by (figuratively) taking my long butterfly out and trading my deltas on the remainder.
Why pull that position out for trading purposes? I look at the butterfly as a straight bet. It either comes in the money or not, and I don't want it's negative gamma aspects to influence my scalping perspective. Floor traders often have a habit of mentally removing cheap options from their position. The objective is to really make gamma work for you while holding some "lottery tickets" in your back pocket. You could generally do this with some cheap OTM puts or calls, or, in my case a long butterfly.
Here's some visuals:
My actual delta position over the next few trading sessions -
My position with the butterfly pulled out -
By removing the butterfly, I'm trading a pure gamma play. I'll make adjustments where the theoretical delta neutral play would have said to do nothing (i.e. stay flat).
I placed an order to buy the shares I sold 50 cents lower (at 34.10) but didn't catch it. Maybe tomorrow.
My high/low targets for tomorrow are 34.58 & 33.93. (Today was the first day in a while where the QQQs almost hit both my targets. When it does that I'm getting almost a 30% SV intraday even though the close to close IV is still hovering around 19%.)
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (3.75X)
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (4.75X)
A relatively quiet day but one with some two way action - just what you need when you're long gamma. I tried to take some advantage of the situation. With the morning spike up, I sold a hundred QQQ (at 34.60) against my NOV position. Right now I'm trying to get as much juice out of my gamma as possible. So I look at my position by (figuratively) taking my long butterfly out and trading my deltas on the remainder.
Why pull that position out for trading purposes? I look at the butterfly as a straight bet. It either comes in the money or not, and I don't want it's negative gamma aspects to influence my scalping perspective. Floor traders often have a habit of mentally removing cheap options from their position. The objective is to really make gamma work for you while holding some "lottery tickets" in your back pocket. You could generally do this with some cheap OTM puts or calls, or, in my case a long butterfly.
Here's some visuals:
My actual delta position over the next few trading sessions -
My position with the butterfly pulled out -
By removing the butterfly, I'm trading a pure gamma play. I'll make adjustments where the theoretical delta neutral play would have said to do nothing (i.e. stay flat).
I placed an order to buy the shares I sold 50 cents lower (at 34.10) but didn't catch it. Maybe tomorrow.
My high/low targets for tomorrow are 34.58 & 33.93. (Today was the first day in a while where the QQQs almost hit both my targets. When it does that I'm getting almost a 30% SV intraday even though the close to close IV is still hovering around 19%.)
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (3.75X)
Tuesday, September 07, 2004
Legging a time spread
Opening position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Trying something new here. I figure that this position is getting relatively complex so I'm trying to add some graphs. [I'm a total neophyte on this blogging thing so bare with me. If you have an idea how I can do this easier than just putting links please let me know.]
Here is how my position opened today.
I looked for some opportunity to stretch out my quickly withering position as I hope to capture some movement in the QQQ index. I looked at both the OCT and NOV expirations to see if there was much value. Maybe because of my discussion with Kai, I was drawn toward the 33/34 bear put spreads. The NOVs were a little cheaper (plus they give me some trading opportunities through the election). Instead of the spread which was trading about $0.35 I decided to go with the straight 34 puts to get some greater downside opportunities. I bought to open the NOV 34 P 10 times and bought 475 shares of the QQQ at 34.40 for an IV of 23.4% (perhaps a little rich but you see how it works with my SEP position in a moment).
See the graph of the puts in isolation here:
This trade moves my overall current position into what looks like guaranteed winner between now and SEP expiration. In reality I have just simply locked in my max loss on the SEP trade at $384. Because of the combination of the butterfly and the NOV calendar along with the 35 mini straddle, I'll breakeven at 34 exactly and make money above 35.60 or below 32.80 before 9/17. In the meanwhile I have some decent gamma to trade from the NOV position.
See the chart here:
High/low one standard deviation targets are 34.72 & 34.05 for tomorrow.
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (4.75X)
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Trying something new here. I figure that this position is getting relatively complex so I'm trying to add some graphs. [I'm a total neophyte on this blogging thing so bare with me. If you have an idea how I can do this easier than just putting links please let me know.]
Here is how my position opened today.
I looked for some opportunity to stretch out my quickly withering position as I hope to capture some movement in the QQQ index. I looked at both the OCT and NOV expirations to see if there was much value. Maybe because of my discussion with Kai, I was drawn toward the 33/34 bear put spreads. The NOVs were a little cheaper (plus they give me some trading opportunities through the election). Instead of the spread which was trading about $0.35 I decided to go with the straight 34 puts to get some greater downside opportunities. I bought to open the NOV 34 P 10 times and bought 475 shares of the QQQ at 34.40 for an IV of 23.4% (perhaps a little rich but you see how it works with my SEP position in a moment).
See the graph of the puts in isolation here:
This trade moves my overall current position into what looks like guaranteed winner between now and SEP expiration. In reality I have just simply locked in my max loss on the SEP trade at $384. Because of the combination of the butterfly and the NOV calendar along with the 35 mini straddle, I'll breakeven at 34 exactly and make money above 35.60 or below 32.80 before 9/17. In the meanwhile I have some decent gamma to trade from the NOV position.
See the chart here:
High/low one standard deviation targets are 34.72 & 34.05 for tomorrow.
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Long QQQ Nov 34P (10X)
Long QQQ (4.75X)
Monday, September 06, 2004
Spread IV (part 2)
Got a comment regarding the usefulness of calculating spread IV and would like to include my response in this blog.
***
Kai wrote:
Kai,
I'll answer your question two ways: specifically and generally.
Specifically, you are correct of course about the call credit spread = put debit spread. The question of whether or not it is a good trade is relative (as are all option valuations). Let's look at it closely. Your parameters are stock at 34, sell 33/34 call spread for $.90 credit, three weeks to expiration. The spread IV is ~ 4%. Assume the stock SV is 20%. The trade is only a good one in these circumstances if it is a long premium (i.e. positive gamma trade). It is in this case (+5 gamma). (It turns into a short gamma play as you near the 33 strike so it becomes an interesting trade to manage delta neutral but that's a separate issue.)
Therefore (mathematically) you are long premium at about 4% in a 20% environment: a huge winning trade. Intuitively you can see why this would be a monster trade - as you said, you just bought an ATM put spread for a dime with three weeks to go. There's almost no way you couldn't trade this to a big payday.
More generally, why is spread IV (or more broadly defined, "position IV") important to calculate and track? First, remember this is all in the context of trading delta neutral. When you're trading neutral the only "currency" that matters is volatility. You're not putting a spread on for a $$$ credit or debit. You are selling or buying IV vs. SV and, by extension, you are buying and selling IV against any prevailing IV position you may currently hold. In my real world example, I was effectively hedging by selling IV at about 16% on my position which I had paid 29% (net after a number of adjustments) - a sure loser but basically I was selling at 16% to avoid selling at 0% later on by not hedging at that juncture. Your example though would be a tremendous find.
So the overall thinking behind spread or position IV is as follows:
[Remember to always add in your execution costs in all these calculations.]
One further lesson from calculating net IV is that you can see concretely how trading from a spread position vs. using a single option frequently offers greater benefits. In your example simply buying the 34 call for 11.4% IV, though maybe a good trade in itself vs. 20% SV, offers much lower probable expectations vs. the spread at 4% IV (assuming you put equal $ investments in each vehicle). Conversely, if you were a seller, you are (in a probabilistic sense) better off selling the single option naked (delta neutral with stock) at 19.9% IV than selling the spread (which in your example would probably be selling the put spread for $0).
Obviously you have to be aware of a variety of other greek risks as you manage your position, but you can be a masterful trader by assessing IV opportunities in a given market, determining whether to be long or short premium, and then develop the ensuing trades by measuring and adjusting your position IV relative to changes in the market.
***
Kai wrote:
"...the spread IV is not the average of the legs IV. Basically you are saying, if all legs had the same IV, what would it be in order for the whole position to have the debit/credit that the position was opened for. But I am not sure about the relevance of this number. To make an extreme example: say 3 weeks to expiration with QQQ at 34 you open a 33-34 call credit spread at 0.90. You sell 19.9% IV and buy 11.4% IV. But the 'spread' IV as you calculate it is only 4%. Does that mean it is a bad trade? I don't think so: Running the numbers it is the same as buying the 34-33 put debit spread for 0.10, for an IV of 4%. "
Kai,
I'll answer your question two ways: specifically and generally.
Specifically, you are correct of course about the call credit spread = put debit spread. The question of whether or not it is a good trade is relative (as are all option valuations). Let's look at it closely. Your parameters are stock at 34, sell 33/34 call spread for $.90 credit, three weeks to expiration. The spread IV is ~ 4%. Assume the stock SV is 20%. The trade is only a good one in these circumstances if it is a long premium (i.e. positive gamma trade). It is in this case (+5 gamma). (It turns into a short gamma play as you near the 33 strike so it becomes an interesting trade to manage delta neutral but that's a separate issue.)
Therefore (mathematically) you are long premium at about 4% in a 20% environment: a huge winning trade. Intuitively you can see why this would be a monster trade - as you said, you just bought an ATM put spread for a dime with three weeks to go. There's almost no way you couldn't trade this to a big payday.
More generally, why is spread IV (or more broadly defined, "position IV") important to calculate and track? First, remember this is all in the context of trading delta neutral. When you're trading neutral the only "currency" that matters is volatility. You're not putting a spread on for a $$$ credit or debit. You are selling or buying IV vs. SV and, by extension, you are buying and selling IV against any prevailing IV position you may currently hold. In my real world example, I was effectively hedging by selling IV at about 16% on my position which I had paid 29% (net after a number of adjustments) - a sure loser but basically I was selling at 16% to avoid selling at 0% later on by not hedging at that juncture. Your example though would be a tremendous find.
So the overall thinking behind spread or position IV is as follows:
- Determine the current SV environment and SV expectations
- Identify long offered IV positions <> SV. Enter the trade(s) with the greatest positive expectations. Ensure that the position is put on delta neutral.
- As the trade develops (i.e. the market and time to expiration change), make adjustments to the position that keep you delta neutral and are profitable to your original IV position (either through additional option trades or via trading the underlying).
- Recalculate your position IV net the adjustments and repeat the decision process based on your new net position IV.
[Remember to always add in your execution costs in all these calculations.]
One further lesson from calculating net IV is that you can see concretely how trading from a spread position vs. using a single option frequently offers greater benefits. In your example simply buying the 34 call for 11.4% IV, though maybe a good trade in itself vs. 20% SV, offers much lower probable expectations vs. the spread at 4% IV (assuming you put equal $ investments in each vehicle). Conversely, if you were a seller, you are (in a probabilistic sense) better off selling the single option naked (delta neutral with stock) at 19.9% IV than selling the spread (which in your example would probably be selling the put spread for $0).
Obviously you have to be aware of a variety of other greek risks as you manage your position, but you can be a masterful trader by assessing IV opportunities in a given market, determining whether to be long or short premium, and then develop the ensuing trades by measuring and adjusting your position IV relative to changes in the market.
Friday, September 03, 2004
Exhaling
Opening position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Short QQQ (1X)
Caught a break on the down open. INTC carried more weight than the in line with expectations jobs report. I covered some of my short position as I bought in my short stock at my downside low target (34.39). This covered the deltas on my two 34 calls I sold yesterday and gave me a theoretical sale on that leg at a whopping 32.8% IV. Nice to finally make a decent trade on this position after a long dry spell. (Of course I took a pretty big naked risk over night, but having a base position allowed me some speculative luxury - yet another reason to always work from a spread.)
So now I'm relatively flat going into the long weekend. My mini straddle at 35 gives me some minimal trading opportunities next week and is the principle reason I've got about $1.50 decay per day - a reasonable price to pay in my opinion. My butterfly is basically a real dog (when you subtract the costs of my adjustments to date). I'll only make some money on this if we close very close to 34 at expiration. The trade today narrowed my max downside to about $400. If we see some volatility pop after Labor Day I may still be able to wring a few drops out of this wet blanket.
One standard deviation targets for Tuesday: 34.42 & 33.77
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Short QQQ (1X)
Caught a break on the down open. INTC carried more weight than the in line with expectations jobs report. I covered some of my short position as I bought in my short stock at my downside low target (34.39). This covered the deltas on my two 34 calls I sold yesterday and gave me a theoretical sale on that leg at a whopping 32.8% IV. Nice to finally make a decent trade on this position after a long dry spell. (Of course I took a pretty big naked risk over night, but having a base position allowed me some speculative luxury - yet another reason to always work from a spread.)
So now I'm relatively flat going into the long weekend. My mini straddle at 35 gives me some minimal trading opportunities next week and is the principle reason I've got about $1.50 decay per day - a reasonable price to pay in my opinion. My butterfly is basically a real dog (when you subtract the costs of my adjustments to date). I'll only make some money on this if we close very close to 34 at expiration. The trade today narrowed my max downside to about $400. If we see some volatility pop after Labor Day I may still be able to wring a few drops out of this wet blanket.
One standard deviation targets for Tuesday: 34.42 & 33.77
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
A gamble
Opening position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (6X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Short QQQ (1X)
Big run-up at the end of the day. I sold my remaining 34 calls on the close to complete the butterfly ( long 33/34/35 four times) and leave me with a mini 35 straddle and my short stock. This puts me with a cap to the upside and a fairly decent downside (the whole spread almost looks like a straight put with a mini-kink in it).
I'm taking a gamble. The market is likely to get hit with some volatility inducing events this morning (I'm writing pre-market). Intel got slammed after the close on curtailed profit warnings, the RNC ended with expected fanfare so now everyone will be scrutinizing the polls for a Bush bump, the jobs number is due today that will be looked at (rightly or wrongly) as confirming or refuting Bush's economic claims, Frances is bearing down on Florida, and there's a long holiday weekend on tap to sort it all out. The real economy, the political spin economy, and real peoples lives all in the balance. (Talk about a perfect storm.)
And my little position is poised for things ending badly. If I'm wrong, and the market moves higher, the trade is essentially finished and I'm out about $440. If things get bearish in a hurry I can recoup my losses and turn positive below 33. Let's see how things shake out.
High/low targets for today: 35.07 & 34.39 with vol being sucked away. We could/should see a real spike today. One way or the other.
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Short QQQ (1X)
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (6X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Short QQQ (1X)
Big run-up at the end of the day. I sold my remaining 34 calls on the close to complete the butterfly ( long 33/34/35 four times) and leave me with a mini 35 straddle and my short stock. This puts me with a cap to the upside and a fairly decent downside (the whole spread almost looks like a straight put with a mini-kink in it).
I'm taking a gamble. The market is likely to get hit with some volatility inducing events this morning (I'm writing pre-market). Intel got slammed after the close on curtailed profit warnings, the RNC ended with expected fanfare so now everyone will be scrutinizing the polls for a Bush bump, the jobs number is due today that will be looked at (rightly or wrongly) as confirming or refuting Bush's economic claims, Frances is bearing down on Florida, and there's a long holiday weekend on tap to sort it all out. The real economy, the political spin economy, and real peoples lives all in the balance. (Talk about a perfect storm.)
And my little position is poised for things ending badly. If I'm wrong, and the market moves higher, the trade is essentially finished and I'm out about $440. If things get bearish in a hurry I can recoup my losses and turn positive below 33. Let's see how things shake out.
High/low targets for today: 35.07 & 34.39 with vol being sucked away. We could/should see a real spike today. One way or the other.
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (8X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Short QQQ (1X)
Thursday, September 02, 2004
Quick note
Opening position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (6X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Short QQQ (1X)
On the road yesterday. Again my scalp orders not hit. Vol really contracting and a holiday weekend looms. The position is basically sitting and losing some minimal decay (about $2 per day). Unless I can get some 2 standard deviation moves my stops wont be hit. Also is I don't get some directional action, selling the additional 34s at these levels will just lock in losses. So I'll let it ride another day.
One standard deviation high/lows for today: 34.56 & 33.89
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (6X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Short QQQ (1X)
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (6X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Short QQQ (1X)
On the road yesterday. Again my scalp orders not hit. Vol really contracting and a holiday weekend looms. The position is basically sitting and losing some minimal decay (about $2 per day). Unless I can get some 2 standard deviation moves my stops wont be hit. Also is I don't get some directional action, selling the additional 34s at these levels will just lock in losses. So I'll let it ride another day.
One standard deviation high/lows for today: 34.56 & 33.89
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (6X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Short QQQ (1X)
Wednesday, September 01, 2004
Thumb twiddling
Opening position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (6X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Short QQQ (1X)
Once again nothing done today. Barely missed a scalp. Put my bid for some stock at my target low of 33.58 (actual low (33.65). The narrow trading range is really playing havoc with my ability to get anything from my gamma. If I can't get a few more $$$ out of scalping, legging into the butterfly will be too expensive. So once again I sit with this now very frustrating position.
I'm still scanning for my next play and GOOG looks like its holding IV at these levels (around 50% IV for DEC and 46% OCT). I obviously don't have much in the way of historic valuations to gauge where this one is going. Yet my experience with Internet stocks and IPOs tells me that this lull can't last forever. The first wave of lock up ends on Friday so I'll be paying careful attention to how the stock reacts then - and next Tuesday as well.
The obvious pressure will be to the downside (but maybe "obvious" isn't the best way to go?). I'm looking at a backspread that I can trade delta neutral. The OCT 100/110 1X2 is looking tempting. I could sell one 100 and buy two 110s for an $0.60 credit. The spread works out to an IV purchase at 44.6%.
From a risk/reward perspective this is kind of iffy. As a vega play, there's a decent $13 per IV point payoff. If we get any serious selling on GOOG vol could pop back to opening day of around 60% and the short deltas I'd have from entering the trade neutral would give some added bonus. If we go the other way the trade would have a fairly hefty max risk of $1100. I'll monitor pricing and volatility over the next few days to see if I have a reason to pull the trigger on this one.
High/low targets for QQQs today: 34.33 & 33.62
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (6X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Short QQQ (1X)
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (6X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Short QQQ (1X)
Once again nothing done today. Barely missed a scalp. Put my bid for some stock at my target low of 33.58 (actual low (33.65). The narrow trading range is really playing havoc with my ability to get anything from my gamma. If I can't get a few more $$$ out of scalping, legging into the butterfly will be too expensive. So once again I sit with this now very frustrating position.
I'm still scanning for my next play and GOOG looks like its holding IV at these levels (around 50% IV for DEC and 46% OCT). I obviously don't have much in the way of historic valuations to gauge where this one is going. Yet my experience with Internet stocks and IPOs tells me that this lull can't last forever. The first wave of lock up ends on Friday so I'll be paying careful attention to how the stock reacts then - and next Tuesday as well.
The obvious pressure will be to the downside (but maybe "obvious" isn't the best way to go?). I'm looking at a backspread that I can trade delta neutral. The OCT 100/110 1X2 is looking tempting. I could sell one 100 and buy two 110s for an $0.60 credit. The spread works out to an IV purchase at 44.6%.
From a risk/reward perspective this is kind of iffy. As a vega play, there's a decent $13 per IV point payoff. If we get any serious selling on GOOG vol could pop back to opening day of around 60% and the short deltas I'd have from entering the trade neutral would give some added bonus. If we go the other way the trade would have a fairly hefty max risk of $1100. I'll monitor pricing and volatility over the next few days to see if I have a reason to pull the trigger on this one.
High/low targets for QQQs today: 34.33 & 33.62
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (6X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Short QQQ (1X)
Tuesday, August 31, 2004
Spread IV
Opening position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (6X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Short QQQ (1X)
Got some downside action today which brought in a little cash (theoretically) my way. I held tight to my position looking for a little more follow through to the downside where I can cover my short deltas by either buying back stock or selling the 34 puts at a little better price. Time is ticking away and the long holiday weekend ahead will devastate any long premium remaining in this position.
Since I basically did nothing I started thinking about looking at implied volatility in a spread situation. While everyone knows that there is an IV for each individual option, it's imperative to grasp how a spread position also has an IV - and it's not just a weighted average of the individual legs.
As an example look at the closing market for QQQ Sep options today (August 30).
33 Call 1.35 Bid - 1.45 Asked (25.8% bid IV - 28.7% ask IV)
34 Call 0.65 B - 0.70 A (21.6% - 23.3%)
35 Call 0.25 B - 0.30 A (20.4% - 22.5%)
With SV right around 21.7% (30 day) it looks like none of these options are good purchase candidates (assuming SV will stay about this level through expiration). So why not just sell premium and ring the cash register? Well the problem is that to make the short strategy work, you eventually need to hedge the position and lock in some of that excess IV. This is where things get interesting.
Let's say you decide to sell the 33 call at 25.8%. If you think that by buying the 34 call at 23.3% you've locked in some decent edge, think again. By plugging this spread into an option pricing model you'll find that the $0.65 credit you receive on the trade backs out to an spread IV of 16.8%. The market maker on the other side just locked in a trade about 5% below SV - almost a sure winner to trade delta neutral until expiration. If you were to buy the call spread (long the 33/short the 34) at the market, you'd be paying 24.4% for the privilege. (And folks think market makers use some sort of devious means to take the customers' money!)
When we do the same calulations on the market prices for the 33/34/35 butterfly the IV spread is even more remarkable. The cash market would be $0.20 debit to $0.45 debit. The market maker buying for 20 cents is getting a spread net IV of 10.4% while selling at 27.3%. The QQQs would have to almost literally park right around 34 to turn that $.20 debit into a loser.
When I plug in all my trades that I've made on this position (including commissions) my net spread IV has been a whopping 29.8%. By looking with a bit of tunnel vision when making my adjustments, I've clearly failed to see the big picture. Once again the market has taken me to school (this time in front of an audience - gulp!). Lesson learned (hopefully).
Game plan for tomorrow: cover with decent follow through below and/or look to sell the remaining leg of the 34 strike to complete the butterfly. One standard deviation high/low targets are: 34.29 & 33.58.
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (6X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Short QQQ (1X)
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (6X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Short QQQ (1X)
Got some downside action today which brought in a little cash (theoretically) my way. I held tight to my position looking for a little more follow through to the downside where I can cover my short deltas by either buying back stock or selling the 34 puts at a little better price. Time is ticking away and the long holiday weekend ahead will devastate any long premium remaining in this position.
Since I basically did nothing I started thinking about looking at implied volatility in a spread situation. While everyone knows that there is an IV for each individual option, it's imperative to grasp how a spread position also has an IV - and it's not just a weighted average of the individual legs.
As an example look at the closing market for QQQ Sep options today (August 30).
33 Call 1.35 Bid - 1.45 Asked (25.8% bid IV - 28.7% ask IV)
34 Call 0.65 B - 0.70 A (21.6% - 23.3%)
35 Call 0.25 B - 0.30 A (20.4% - 22.5%)
With SV right around 21.7% (30 day) it looks like none of these options are good purchase candidates (assuming SV will stay about this level through expiration). So why not just sell premium and ring the cash register? Well the problem is that to make the short strategy work, you eventually need to hedge the position and lock in some of that excess IV. This is where things get interesting.
Let's say you decide to sell the 33 call at 25.8%. If you think that by buying the 34 call at 23.3% you've locked in some decent edge, think again. By plugging this spread into an option pricing model you'll find that the $0.65 credit you receive on the trade backs out to an spread IV of 16.8%. The market maker on the other side just locked in a trade about 5% below SV - almost a sure winner to trade delta neutral until expiration. If you were to buy the call spread (long the 33/short the 34) at the market, you'd be paying 24.4% for the privilege. (And folks think market makers use some sort of devious means to take the customers' money!)
When we do the same calulations on the market prices for the 33/34/35 butterfly the IV spread is even more remarkable. The cash market would be $0.20 debit to $0.45 debit. The market maker buying for 20 cents is getting a spread net IV of 10.4% while selling at 27.3%. The QQQs would have to almost literally park right around 34 to turn that $.20 debit into a loser.
When I plug in all my trades that I've made on this position (including commissions) my net spread IV has been a whopping 29.8%. By looking with a bit of tunnel vision when making my adjustments, I've clearly failed to see the big picture. Once again the market has taken me to school (this time in front of an audience - gulp!). Lesson learned (hopefully).
Game plan for tomorrow: cover with decent follow through below and/or look to sell the remaining leg of the 34 strike to complete the butterfly. One standard deviation high/low targets are: 34.29 & 33.58.
Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (6X)
Long QQQ Sep 35C (5X)
Long QQQ Sep 35P (1X)
Short QQQ (1X)
