An option trader's diary

Trader tax expert reference?

2005-01-03T18:11:00.000-06:00

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

Back to business as usual

2004-09-25T13:07:00.000-05:00

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)

Anatomy of a trade

2004-09-19T22:23:00.000-05:00

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)

When to scalp

2004-09-17T05:35:00.000-05:00

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...

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)

Some welcome selling

2004-09-15T21:40:00.000-05:00

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)

Yawner

2004-09-15T01:54:00.000-05:00

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)

Emptying the well

2004-09-13T22:21:00.000-05:00

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)

Continued follow through

2004-09-12T15:14:00.000-05:00

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)

Two bits and then some...

2004-09-10T01:54:00.000-05:00

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)

Scalping like a pro(?)

2004-09-09T01:22:00.000-05:00

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)

Legging a time spread

2004-09-07T21:22:00.000-05:00

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)

Spread IV (part 2)

2004-09-06T16:02:00.000-05:00

Got a comment regarding the usefulness of calculating spread IV and would like to include my response in this blog.

***

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.

Exhaling

2004-09-03T22:44:00.000-05:00

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)

A gamble

2004-09-03T05:45:00.000-05:00

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)

Quick note

2004-09-02T07:26:00.000-05:00

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)

Thumb twiddling

2004-09-01T04:29:00.000-05:00

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)

Spread IV

2004-08-31T00:08:00.000-05:00

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)

Calls are puts and puts are calls

2004-08-29T23:36:00.000-05:00

Opening position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (6X)
Long QQQ Sep 34P (3X)
Long QQQ Sep 35C (4X)
Short QQQ (1X)

Continued to unwind this position a bit as vol movement has not been what I anticipated. As I look at the position and how it has evolved, there are a couple glaring problems. First I've held on a bit too stubbornly to my short bias through this trade. Second if I hope to transform this position into the 33/34/35 long butterfly, I've got to look at the synthetics.

I addressed the short bias by purchasing another 35 call which essentially limits by losses should we continue to run up higher. To eliminate the conversion (short call/long put at the 34 strike) I again leveraged up the put strikes by selling my three 34 puts and buying one 35 put for a $0.40 credit. My goal for the butterfly is to be short net 8 contracts at the 34 strike. I can do this with either calls or puts and will look at IV to see which is the better play should we creep higher on Monday. The extra 35 strikes give me some insurance and upside play should we get a big celebration for whatever reason above 36 on QQQs. Friday's trades also severely reduced my decay (theta) into the weekend (remember this was a 3X1 ratio spread taken in isolation).

The problem with all these adjustments have been my additional commissions. I'm now down about $240 on a trade that I originally put a mental stop at a loss of $320 (4 X -.80; see the original post in this blog). So I don't have a lot of room on the downside before I really need to pull the plug. With the current position I have on it looks like my max downside is -$440.

Okay, I've still got my W shaped straddle with a bit of a downside lean. My big risks are shrinking vega and a creeping market that pins at 35. I need some volatile movement in the QQQs to hope to scalp some of my remaining premium (sounds like a broken record doesn't it). I'll be looking to sell the other two 34's in the next day or so and then simply manage the "wings" (which are my extra 35's and my short stock).

My one standard deviation high/low targets (which have been miserably unusable the last few days) are 34.87 & 34.15 for Monday.

I'm starting to look around for another opportunity and I of course couldn't keep my eyes off GOOG on Friday. Over 60,000 contracts traded; so huge liquidity. The options opened at 60% IV (which I actually thought might be too low). By the end of the day Sep ATM calls were trading near 40% IV(!!!). If you had the balls to sell 'em at the open, you made a killing. I actually expected IV to range upwards of 100%. I remember back in 1998 trading CMGI as a market maker. When we opened that stock we at least had some historical data to go off of and we still opened the options at about 75%-80% IV (and this was before the huge dotcom craze was really in full swing). Generally market makers want to build an inventory so they'll price things high and bring it down when their "boat is taking on too much water." GOOG seems awfully tempting at these levels considering the newness of the stock, the intense focus on its IPO and the fact that insider lockup starts to unwind in the next week to ninety days. I can't believe this thing won't really start to rock (first week trading - if that's any guide - was a paltry 27% SV) into autumn. And the Dec options are offered at about 50% IV. I believe I'll be looking for my next play here.

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)

Reigning it in

2004-08-27T00:17:00.000-05:00

Opening position:
Long QQQ Sep 33C (4X)
Long QQQ Sep 33P (2X)
Short QQQ Sep 34C (6X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 34P (2X)
Short QQQ (1X)

The gas is definitely running out on the QQQs. More sideways action in a very narrow range. 10 day SV is sliding toward 52 week lows. Although 30 day SV is still inching higher, the short term quiet will eventually be felt. I've still got that trader itch that tells me some big movement is near. If I weren't in this trade, I think I would be looking for an entry point to put on a fresh backspread position - though probably not with the Sep expiration. But my risk manager self is saying get out and cut your losses.

Plan A of this whole exercise was to make money. Plan B is to maintain discipline. So while I haven't totally capitulated yet, I'm set to reign things in here.

The first order of duty is to take care of the simple stuff. I made a trade today that is actually a decent adjustment for a standard bull or bear position that doesn't go your way. I sold my two 33 puts (the remnants of the down leg of the original straddle) and bought an additional 34 put for even money. This still gives me some downside at a little closer strike to the current price. I've basically improved the probabilty of payoff while reducing some risk (I lowered my theta).

To see why this is sometimes a nice adjustment strategy, here's an example: with a stock at $50 you buy two $50 puts as a directional play because you think the stock may tank. A few weeks later the stock is now at $54. You look at the option prices and see that the 55 strike puts are trading at about twice the current market price of the 50 puts. You can make an adjustment here by trading the 2 by 1 (sell your two 50 puts and buy one 55put ) for even money. Your cost basis is still the net debit of your original purchase. But you've moved your probability of being in the money a little closer. If the stock goes back to $50 by expiration, your 55 put is of course worth $5 vs. your original 50 put position which would be worthless.

Over the next few days I'll be looking to unwind this position or convert it into the butterfly depending on prices. I've got a a bit of a downside lean to the position and will need to scramble if we spike higher. My high/low targets for tomorrow are 34.71 & 34.00.

Closing position:
Long QQQ Sep 33C (4X)
Short QQQ Sep 34C (6X)
Long QQQ Sep 34P (3X)
Long QQQ Sep 35C (4X)
Short QQQ (1X)

Ho hum.

2004-08-26T02:09:00.000-05:00

Opening position:
Long QQQ Sep 33C (4X)
Long QQQ Sep 33P (2X)
Short QQQ Sep 34C (4X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 34P (2X)
Short QQQ (1X)

The QQQ's slow upward crawl resumed today. Well I'm looking to salvage this trade by legging into what will eventually be a (hopefully) free long butterfly. I sold two more Sep 34 calls near the close. This got me a little bit short (about 100 deltas) that I'll look to cover on any minor downtick in the a.m. If I get caught with my pants down and the market runs up against me tomorrow. I'll pretend I'm actually short some premium and try to look the other way before chasing this one (as a safety net I still have my 35 calls which are giving me enough gamma to get me flat if we're actually up over 35 or so). If we stay in around here I'll look to sell my 34 puts for a decent price (> 21% IV ).

I really hate to give up on this trade because I know the unofficial end of summer is just a week away and that usually means a return to higher volatilities. Lots of market externals to grapple with like the RNC, wall streeters returning from vacation and even the GOOG option launch (plus the the post IPO thaw in which big investors can now sell some shares). The 30 day SV is still rising (above IV by about 1% now) but the last week or so has damped the prospects for the near future.

If I'm patient, skillful and more than a little lucky I'll at least salvage this by getting into the 33/34/35 butterfly as I've discussed before. To do this for little or no risk is an ideal trade. It may not be the jaw dropping winner that doubles or triples overnight, but it is really one of those situations that the pros constantly strive for: free options. There is no better feeling than when you manage to finagle or finesse a convoluted spread into some free calls or puts. You set them out of mind and then watch with a great deal of pleasure as they come home big every once and a while.

Tomorrow's high-low one standard deviation watch is 34.85 & 34.15. (As any gambler might say. we're really due for a big move soon. Just one more roll of the dice...)

Closing position:
Long QQQ Sep 33C (4X)
Long QQQ Sep 33P (2X)
Short QQQ Sep 34C (6X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 34P (2X)
Short QQQ (1X)

Gone fishin'

2004-08-24T23:59:00.000-05:00

Opening position:
Long QQQ Sep 33C (4X)
Long QQQ Sep 33P (2X)
Short QQQ Sep 34C (4X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 34P (2X)
Short QQQ (1X)

Sideways with narrow trading today. I made no adjustments to the position.

Here's what's happening to volatility: IV is dipping from where I entered the original trade while HV is creeping up. On a 30 day basis HV is actually now slightly above IV. I'm faced with a tough decision. The last few days have given me no true scalping opportunities - a pretty clear sign that I may be in a tough spot to make this trade work. On the other hand, if HV is going to continue up I can actually add to this position with something like a "volatility cost averaging" akin to dollar cost averaging which some traders advocate. The problem with this latter alternative is that I'm adding overall dollar risk to the trade (which I've successfully worked to reduce) and the clock is really starting to tick on Sep expiration.

One of the better market makers I know once compared option trading to angling. In both cases, there is a lot of waiting and watching in which the "angler" is positioning himself to make quick decisions. The angler and trader both use their knowledge and experience to locate high probability spots to snare their prized catches. And even after all the planning and patience, more often than not, the hook comes up empty.

What I've got right now is a rather puny fish. I'll give it a couple more tries before I toss this one back.

My high /low one standard deviation targets for tomorrow: 34.38 & 33.68.

Same basic game plan but with the actual vol starting to outrun the options, I'll look to scalp the stock.

Opening position:
Long QQQ Sep 33C (4X)
Long QQQ Sep 33P (2X)
Short QQQ Sep 34C (4X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 34P (2X)
Short QQQ (1X)

Takin' what's offered

2004-08-24T00:18:00.000-05:00

Opening position:
Long QQQ Sep 33C (4X)
Long QQQ Sep 33P (2X)
Short QQQ Sep 34C (4X)
Long QQQ Sep 35C (4X)
Short QQQ (1.5X)

Started to see the choppy intraday action that is so welcome to a gamma scalper. Unfortunately the movement didn't hit the thresholds I was looking for. So I "massaged" the position a bit by making one small trade.

Near the high of the day I took a shot at buying back some premium that I had sold to reduce my theta over the weekend. To accomplish this I bought two 34 puts. I then waited for a little retracement, and got filled as I bought some stock (50 shares) to hedge the puts. This was a cheap purchase (about 20.5% IV). My only concern is that overall vol (IV & HV) I've been betting to rise may be stalling out.

My thinking here was to tweak the greeks a bit to give me a little more bang for the buck. Quantitatively my risk increased as gamma went from 111 to 153, theta went from -$5.67 to -$8.58 and vega went from $15.79 to $22.88. In exchange, my end of day maximum dollar risk to this position declined to -$349 (i.e. this is the most I can now lose on this position). and my P/L, while still negative is only -$107. So in qualitative terms I increased the payback if I'm still right on my vol call while (because I bought the premium so cheaply) I improved my P/L and reduced my overall $$ exposure.

If this all seems complicated let me try to put it in some perspective. If we isolate the single spread trade I made today we can see that I put on a slightly bearish position (-95 deltas on the puts vs. 50 shares of stock) that has a decidedly decent kick with a downside move on the stock. If someone were bearish on the QQQ they could either short the stock, buy puts outright or do some kind of bear spread. The spread I chose has a definite limited downside (I paid $0.65 for the puts and bought stock at 34.10 making the most I could lose on this position equal to approximately $150 inc. comm.) The alternative of just shorting stock would pose significantly more risk to the upside should I be wrong and less bang on the downside. If I weren't trading delta neutral this would be a nicely priced, leveraged bear spread.

Now in the context of my existing position I essentially swapped the puts I bought for 50 shares of stock that I was short. Thus I limited my overall maximum $ risk while improving my potential returns. This would have been a good trade by itself. But in conjunction with my ongoing position, it was, if not a home run, at least a very solid line drive single.

So nothing much has changed in my overall strategy (and strategy shouldn't be changing daily anyway - unless conditions warrant it). I've still got what looks like a "W" shaped long straddle. My position is a little friendlier to some nice downside action and I will continue to scalp gamma should the QQQ's retest lower levels. If we move higher I am fairly flat, but a good upside move will allow me to leg into the long butterfly.

My one standard deviation high/low for tomorrow: 34.39 & 33.69. I'll be looking to sell some calls on an up move and buy some stock down below. But I'll, of course, take a look at what other opportunities I'm offered at either threshold.

Closing position:
Long QQQ Sep 33C (4X)
Long QQQ Sep 33P (2X)
Short QQQ Sep 34C (4X)
Long QQQ Sep 35C (4X)
Long QQQ Sep 34P (2X)
Short QQQ (1X)

Circling the wagons

2004-08-21T00:09:00.000-05:00

Opening position:
Long QQQ Sep 33 straddle (4X)
Short QQQ Sep 34C (2X)
Long QQQ Sep 35C (4X)
Short QQQ (1.5X)

Okay I'm two weeks into this experiment in self discovery. As I read over some of my earlier postings I realize that this diarization process can be a little hermetic. Let me recap for those just joining us and clarify some issues for those that have been playing along.

Before entering the trade I tracked the QQQ index. For all my option trading the main thing I look for in identifying an opportunity is favorable edge. By edge I mean the potential for entering a position at a certain relative volatility level, generally referred to as "implied volatility" or IV, that is below where I believe I can hedge or close that position. In this instance I was looking for a long gamma opportunity, so I'll discuss my thinking from the "buy" perspective. But the logic is easily reversible from the "sell " point of view.

This initial analysis requires that I look at 1) the historical (or statistical) volatility (HV) of the underlying security, 2) intraday historical volatility of that same security and 3) IV of the array of options trading on that underlying. I look at the relative history of these three volatilities and determine if all of them are at the low end of their longer term ranges. Further, I look at the trend of the HV; I like to see what I guess technicians would view as a developing uptrend. It is my experience that volatility is a mean reverting process (i.e. values oscillate above and below a long term mean value in fairly cyclic patterns). Therefore I'm looking for a new up cycle in the actual HV of the underlying. The final piece of the analysis is to look at the IV of the available option alternatives. If IV is below HV it's almost a sure thing. But generally IV is racing ahead of HV in anticipation of a new uptrend.

This is why I try to get some sense of the "intraday" vol. It makes intuitive sense that there are a lot more gyrations intraday then are reflected in a standard close to close vol calculation. This additional movement is where I will be trying to pickup fractional hedging opportunities over the life of my trade. Consequently I will be comfortable with not only a rising HV but a broadening intraday HV as well.

So down to concrete history. On August 9, my analysis showed the QQQ at about 21% HV with IV around 24%. Both volatility levels have been rising since lows in early July. My estimate of intraday IV was around 29%. [I calculate this by using a standard 30 day vol calculation but instead of the close to close values, I calculate both a previous day close to next day high and previous close to next day low then sum these two together.] With QQQ HV rising and intraday HV at a decent premium (and also rising) I felt comfortable entering a trade at the "price" of 24% IV.

The next decision was to determine which option strategy to use. I've never found a totally reliable way to predict market direction, so I like to use a spread scenario that gives me a good foundation to trade off of. Basically you could buy any option that meet your expiration comfort level and that are relatively the cheapest. With the index around 33, I could have bought the 32 calls and sold stock to get neutral. Or I could have put on a backspread. Or I could have bought a straddle. Frankly, I chose the straddle because there were some discussions going on in a couple online newsgroups about how to gamma scalp a straddle.

Actual (vs. paper-) trading is a great means to clarify your thinking and test your decisions. So I bought the 33 straddle four times.

As the trade progressed I continued monitoring (and continue to track) what volatilities are doing. All are continuing slightly higher confirming my original decision. This week has been a bit of a stumble as I oversold some deltas into a very strong, mostly uni-directional uptrend. My current position as of today's close , including all commissions, has me down on paper about $121 on the trade. I 've reduced my risk somewhat from an initial $950 to about $475 (this is my absolute potential downside including the paper loss). If I see my paper loss double I will most likely exit the trade, but until then I will be working to make this a winner.

On to today's actions. I had to check my calendar because this week looked like the ghost of 1999 come to life again. Nearly every day has been a steady climb from the get-go and Friday was no exception.

Without any decent two-way movement, it's impossible to make adjustments to a long gamma position. To succeed, you have to be clairvoyant enough to hold off on covering any deltas until the move is over. Of course the problem is to know when the "over" is really over. So I picked my decision points and made my moves as can be reviewed by previous entries in this diary.

Today gave no relief to my position's downside bias so I decided to focus on repair and contingency. Right now if the QQQs continue their incremental climb, the optimal goal for me will be to convert this whole position into a long butterfly. (Note: yesterday I mistakenly called it a short butterfly ). If I play things correctly I should be able to make the transition into the butterfly for close to nothing. This would in effect give me "free money" should the index expire anywhere between 33 and 35.

So what steps did I take today. Basically my concern was to reduce my decay over the weekend and get delta neutral. As the market was rising midday I shedded two 33 puts from the original straddle and near the close I sold two more of the 34 calls. If I were more blog savvy I would find a way to put some graphs here but my original straddle position now looks like a "W." I still am positioned to reap huge rewards on a big move of +/- 5%. The closing position may sound complicated but keep in mind that by doing three things (closing my stock position, selling my remaining 33 puts and selling 4 more 34 calls) I will have converted this whole beast into a plain 33/34/35 long butterfly. If the market moves up to around 35, I should be able to accomplish this at a net cost very near zero. If the market reverses here, I will continue to trade in and out of my (modified) straddle.

My Monday upside/downside one standard deviation targets are 34.32 & 33.60.

Closing position:
Long QQQ Sep 33C (4X)
Long QQQ Sep 33P (2X)
Short QQQ Sep 34C (4X)
Long QQQ Sep 35C (4X)
Short QQQ (1.5X)

Solid construction with a 2 X 4

2004-08-19T23:03:00.000-05:00

Opening position:
Long QQQ Sep 33 straddle (4X)
Short QQQ (2.5X)

For a moment at the open today I thought it was "deja vu all over again." Gap down. Followed by a quick reversal launch to the upside. This time I was taking no chances with more continuance of the rally. I put the backspread on for even (BOT 4 QQQ Sep 35 C and SLD 2 QQQ Sep 34 C to open). Again my reasoning here was to guard against a runaway market rally while giving me some additional edge ( the 34s sold for about a half point higher IV).

Backspreads are among my favorite trades when I believe vol is rising. They have a lot of characteristics of a straddle when you are trading them delta neutral ( they give a nice "risk smile" graph) plus I generally only put them on for either no cost or a credit. Also when you're looking for a big move they are a cheap way to take a shot - especially if you can ratio the trade at 1 X 2.5 or 1 X 3 for even. In the present exercise the backspread complements my straddle and will eventually give me real leverage to the upside should the rally resume. Or, should we consolidate around this level, I can fairly easily convert this entire position into 33/34/35 short butterfly for very little or no cost. (To do this I'd sell my 33 puts and 6 more 34 calls which would leave me with the butterfly on four times - ignoring my short stock . If I did this where they closed today my net cost - and therefore total risk of the butterfly - would be about $10 per spread or $40 total. The max reward would be $90 per spread or $360 total if the QQQ expires dead on 34.) On the downside, my present position is virtually unaffected . So this simple, no cost adjustment improved my downside, gives me flexibility if the market stagnates and doesn't hurt my downside-weighted straddle.

Back to the day's trading....

The rally quickly petered out and we had some sideways/negative action for the rest of the day. The QQQs did trade low enough to hit my one standard deviation downside target (33.44). Since I was content with my backspread I didn't feel the urgency to jettison my entire short stock. So I only bought back 100 shares at 33.44 which is basically a wash that covered my short sale at 33.70 yesterday plus all my commissions from the last couple sessions.

Game plan for tomorrow. With the weekend here, decay creeps up on my long position so in addition to covering my remaining short stock, I'm ideally looking for a means to sell some premium. I'll need some cooperation from the market and here's hoping that expiration Friday delivers some meaningful action. My 1SD target high and low for tomorrow are 33.97 & 33.26 respectively. I'll cover my short stock at the low if the opportunity presents itself. If we're down another .20 or so I'll look to sell either the 34 calls or buy some stock. If conversely we head back up strongly to say the 34.20 area I may look to begin a leg into the butterfly by selling a couple 33 puts and selling a couple 34 calls.

Closing position:
Long QQQ Sep 33 straddle (4X)
Short QQQ Sep 34C (2X)
Long QQQ Sep 35C (4X)
Short QQQ (1.5X)

Mama said there'd be days like this...

2004-08-18T20:51:00.000-05:00

Opening position:
Long QQQ Sep 33 straddle (4X)
Short QQQ (1.5X)

Gap down on the open. I put a limit order a dime below to cover my shorts. Needless to say the market reversed before I could say "buy." (The low was 33.01; my limit was 32.96). Then a rocket ship up the rest of the day.

Days like this are the bane of every long gamma trader . Vol is still creeping higher - the reason I entered this trade in the first place. But the movement is all uni-directional. Well at least for the last four days in a row!

When the market never reversed its mockingly, effortless climb by late a.m., I put in some orders above and below and went for a bike ride. A long one. (Come to think of it that was the only "long" position I took all day.) When I came home I was short another 100 shares at 33.70 with the QQQ closing near its high at 33.85.

Okay assessment time. I've almost capped my upside by overselling some deltas. I played my expectations and got beat today. What do I mean by expectations? Well its simply probability times some quantity or value. I'm right about 50% of the time on these calls, but my win ratio is about two to one. So 50% of the time I win 2 and 50% of the time I lose 1. That makes this play yield +.5 over the long term (.5 X 2 - .5 X 1 = .5).

My game plan for tomorrow is 1) build a contingent plan for more upside follow through and 2) should we retrace a bit, not jump the gun by buying too soon. My one standard deviation targets for tomorrow are 34.15 & 33.44. That downside target is precisely breakeven on my short stock. I think I have to bite this one and cover - IF we go down there.

If we stay flat (or meander quietly) on the day, I will look at possibly tossing a backspread onto the mix. The 34/35 1 X 2 is trading at even (I'd sell two 34 calls and buy four 35 calls). This gets me back a few deltas and puts a kink in my straddle that makes it look like a swaying hammock. I win with a big upside move and I get to leg out of all my shorts for some profit if we go down. If we just sit here I've reduced my theta even though decay is not a big problem just yet.

Now if we rocket again, I've got some soul searching to deal with. Do I gut it out and hope for a reversal or do I leg the one by two (i.e. buy the long side first and hope to sell the short leg for a bigger credit)? Stay tuned...

Closing position:
Long QQQ Sep 33 straddle (4X)
Short QQQ (2.5X)

Positive expectations

2004-08-17T22:19:00.000-05:00

Opening position:
Long QQQ Sep 33 straddle

A little pop out of the box on the QQQ. I tried to sell half my calls with the stock at 33.41 but got left at the altar (missed by a nickle - though some traded at my price, alas, not mine). Regrouped and shorted 150 shares at 33.28 which was basically overselling my deltas. I was hoping for some whipsaw action that would bring the stock back to around unchanged. The market, as it often does, failed to cooperate with my grand design and flatlined for the rest of the day.

Ok what was my thinking here? I decided to oversell my gamma for a few reasons: 1) the quick rally at the open after a couple days of pure uptrend (I "sensed" a stall), 2) it's expiration week and I expect to see two-way action at some point , and 3) I know that if I'm wrong and the rally continues without pause that I have enough gamma to make up the difference. Sometimes you have to take chances and the jury's still out on this one. Over the long haul this risk seems to pay off for me and I'll look at it as another instance of playing positive expectations.

This brings up one of the advantages (at least from my perspective) of trading from the long side - you can take some directional risk and the position is a little more forgiving. On the other hand, if you look at a chart of IV vs. SD in the QQQ over the last year, you probably think I'm an idiot for buying preimum. But my reason for being in the trade is that I'm a student of the option markets and time and again the mean reverting (or cyclical) nature of volatility is consistently apparent. I've taken a shot on this trade by anticipating that the cycle is entering an upward phase. We'll see if I pass this test.

My single standard deviation targets for tomorrow are 33.55 and 32.85. I plan to add to my shorts a bit higher ~33.70. (Again, I'm hoping to sell some premium vs. the stock if the opportunity presents itself .) I'll go flat at the low target. Vol is holding steady (IV and SD); I'll see the trade through this week, at least, simply because anything can happen during an expiration (even dull, dull August) and I'll try to capture what ever the market gives me.

Closing position:
Long QQQ Sep 33 straddle (4X)
Short QQQ (1.5X)

Edge & hedge 2

2004-08-16T23:58:00.000-05:00

Opening position:
Long QQQ Sep 33 straddle (4X)
Long QQQ (1X)

Covered my short stock for $0.38 profit at $32.89. After commissions my adjusted cost of the spread is $1.93. The straddle closed today bid at $1.95 so even with my relatively few trades against my long premium, I'm ahead of the game. My intraday vol analysis is ticking up again so I'm sticking with the trade. Narrowly missed selling out half my calls at $1.15 (they traded 1.10). I'll be looking to shed some premium tomorrow at 33.18 or 32.49 if I can sell at good IV. Otherwise I'll likely trade some stock against my deltas. August expiration is approaching and I'm hoping we jettison most of the summer dullness and start rocking on this straddle in the next few weeks.

Chatted with some traders today. One thing that strikes me is the number of references some traders (especially those that have been at it for more than a year or so) often quote at which IV level they buy or sell an option. Of course I make a great deal out of measuring and monitoring IV and underlying SV. But what is curious is the number of times I've heard folks say "I bought the 50 calls at 32 IV," or "I shorted some puts at 50 vol." When I ask what they did against those trades, I'm often met with a curious, "Nothing. My charts show it's (i.e. the underlying) moving up."

What I try to point out is that IV is meaningless unless you actually place a hedge of some sort against the position. IV is a relative measure at a particular point in time. If you wait to leg into a spread or place a stock order away from the market, you are effectively legging into an assumed IV. That's okay. Off the floor you have to learn how to do this all the time. But if you trade nothing against your long call, short put or whatever, you're simply not using options to deliver all the flexibility and opportunity that they create. I'm not trying to judge traders - the market does that to all of us. I'm really trying to hammer home to myself just how important it is to recognize (and hopefully avoid) fundamental trading flaws.

Without a hedge there is no edge.

Closing position:
Long QQQ Sep 33 straddle

My little option shoppe

2004-08-15T20:57:00.000-05:00

Opening position:
Long QQQ Sep 33 straddle (4X)
Long QQQ (1X)

Narrow action on Friday. The market never hit my decision points. So nothing done. While watching the market drift nowhere I started musing about "real" world analogies to option trading. One possiblity is to think of trading - particularly gamma scalping from the long side - as very much like operating a retail store.

Just like selling goods, a long premium player buys a certain amount of inventory in bulk - preferably at wholesale rates. The business objective is thus to package and market that inventory in smaller parcels at retail prices. The goal is to somehow manage to turn a profit after all operating costs are deducted. And hopefully this all transpires before the inventory perishes or becomes obsolete.

I like this analogy because it points out how trading is like any other business. You have to know your market and what demand, competition and "consumer" behavior is all about. You have to negotiate and acquire inventory at reasonable rates and in manageable quantities given your fixed and working capital. You have to monitor and control your fixed and variable operating costs. You have to attempt to diversify your offerings to meet changing market conditions and dynamics. And you have to insure against catastrophe to ensure that you stay in business.

Of course parallels are only useful as long as they are instructive. In my current position, I'm anticipating that customers will be coming through my doors everyday. And I'm hoping that they'll buy my wares at my advertised prices. I'm not particularly diversified to say the least. In fact instead of an option store I'm more like the itinerant subway hawker of a single gold watch. Let's just hope that some influx of tourists will be clamoring for my product in the next few days or I'll be pitching this one down some sewer pipe...

Enough inanities. I'm watching vol very closely and want to see some follow through to the upside (IV that is, though some upside price movement would prove beneficial as well.) My one standard deviation targets for Monday are 32.79 and 32.13. I'll probably be fading any opening move that hits either target hoping to get some kind of ping-pong action over the next few days. I'll look to scalp my deltas by trimming my longs as we move closer to August expiration.

I'm praying for some movement coming out of the late summer doldrums. Maybe some Hurricane Charley pessimism will bang the market in the A.M. (Geez, now I'm thinking like a callous trader..."How's this human catastrophe gonna effect my lousy 10-lot?") Oh well...

Closing position:
Long QQQ Sep 33 straddle (4X)
Long QQQ (1X)

Trending days

2004-08-13T05:28:00.000-05:00

Opening position:
Long QQQ Sep 33 straddle

When you're trading gamma your fantasy is to have a trading day where market participants don't know which direction to go - and are in an awful hurry to get there.

Instead of wild gyrations we got a unidirectional down day yesterday. I'm not much of a market technician so I don't know if days like this are a product of strong market conviction or simply part of some great cosmic randomness. (Personally, and spiritually perhaps, I worship randomness.)

For now I'll take what the market's giving me - I BOT QQQ at 32.51 and covered my deltas (about 25% of my position).

My one standard deviation targets for today are 32.75 & 32.08. I'll look to cover another 25% of my position on a down move and let my long position run to 32.89 (1.5 SD move) if we get a reversal.

Overall the volatility rise that led to me taking this position took a little pause yesterday. A volatility stall out is my biggest concern at this point and I'll be monitoring it closely. I always like to be short some premium going into the weekend so if we get some early action either way I'll be looking to hedge my deltas by preferably selling the options vs. just trading stock.

Closing position:
Long QQQ Sep 33 straddle (4X)
Long QQQ (1X)

Gamma scalping

2004-08-12T00:06:00.000-05:00

Opening position:
Long QQQ Sep 33 straddle (4X)
Short QQQ Sep 34 combo (2X)

Couldn't have asked for a better open. SLD to close my combo for 1.35cr. giving me .70 on the scalp. This brings my straddle cost down to a fraction over $2.02 dr. with 24 trading days to go. The gap down at the open bolsters my opinion of vol creeping up in the QQQs. I expect more churning around this level (but the late market rally may mean some more upside to come). I'll put in orders to cover my gamma at 33.48 & 32.51 tomorrow. I'd like to see some whipsaw motion (and catch a couple breaks daytrading the moves).

Here's my theory about gamma scalping a position. If I'm long gamma, I need very concrete entry and exit price points. I like to cover my deltas around intraday standard deviation moves. As an example the above prices represent two standard deviations up (33.48) and one SD down (32.51). Depending on my position, I'll usually cover 25% at 1SD, 25% more at 2SD and let it run with a powerful move beyond that. The point is to try to capture some movement without overtrading or burning out all your deltas too soon. I like looking at how volatility is actually playing out on both the upside and the downside. I track the previous day's close to both the following day's high and low and use the typical SD calculation to see how they differ.

Right now I'm seeing greater downside vol. That's why my stop/cover points look a little skewed: 1SD down is -$0.41, 1SD up is +$0.28. With today's close at 32.92 that gives me a 1SD range of 33.20 to 32.51 for tomorrow. The 1SD range should hold about seven days out of ten. I expect a sizeable move like today (down almost 2SD on the open) maybe two days out of ten. I plan my scalps with the hopes of hitting those SD targets then fading in the other direction. I'm not really a day trader but I could see someone making a refinement on this type of calculation to play the markets that way (of course how to play it is the trick - as a reversal indicator or as a momentum entry indicator???) When I'm not seeing these expectations come to pass, I know I'm wrong about my vol estimates and I know its probably time to exit a backspread (i.e. long gamma position).

When I'm short gamma, I'm tracking the very same market activity. The difference is that I add a set time frame for making my adjustments as opposed to only using price thresholds. The goal here is not to overtrade your short gammas. So, for instance, if I were short the very same straddle, I may have chosen to only cover my exposed deltas at say 15 minutes before the close everyday. Today, at that point I would have seen that my position was only slightly short near the close and I probably would have done nothing. If there were no transaction costs and truly frictionless, gapless markets, you could theoretically cover your negative gamma at very small intervals. Not gonna happen.

The trick when your short gamma is to avoid obsessing over every tick intraday. I find that late breakfast followed by a long lunch is the proper way to play your verticals. (Anything to avoid looking at the markets; it's no wonder so many traders are avid golfers.)

Normally I'm of the opinion that options are a zero-sum game. But my above examples actually demonstrate how I could have made money being either short or long the same straddle. Clearly there is a missing theoretical action or actions that should have been taken by the short gamma trader. In a true zero-sum the short trader should have sold lower and bought higher (transfering the difference to the long gamma scalper). Was this a lucky (non)trade? Does it catch up to the premium sellers in the long run?

Something to ponder for another day.

Closing position:
Long QQQ Sep 33 straddle

Edge & hedge

2004-08-10T17:14:00.000-05:00

Opening Position: Long QQQ Sep 33 straddle.

Everything on schedule BOT the Sep 34 combo for .65 dr. (Short call/long put = to short stock at 33.35) to cover my gamma on a two standard deviation up move. Sure enough the market likes Greenspan to be consistent with his/the Fed's policy to avert stagnation (i.e. instill some price inflation into the markets). (By the way this policy of creeping inflation bodes well over the next couple years for big cap stocks and particularly heavy manufacturing, oil & defense stocks.)

So now I'm faced with a decision should the rally continue. I've taken out half my deltas on the straddle and will probably let it run at least another two standard deviations tomorrow (upside target = 33.77). If it hits the upside I'll short another quarter of my position. If we reverse I'll be dancing if I can cover my combo around 32.79.

Whether you're on or off the floor, to me you're a pro if you play options with an "edge & hedge" mindset. By this I mean finding situations with some theoretical or probalistic positive edge and then controlling or spreading off the risk by countering with a position with either more edge or neutral edge. On the floor edge is palpable: buy on the bid, sell on the offer. Upstairs (or in your den, or wherever you trade) edge is more elusive.

With this straddle I basically "manufactured" edge by using my analysis to gauge that the price I paid was significantly less than the value. I could allege this only by asserting that the implied vol priced into the options was less than the actual vol to come. I do this by looking at historical volatility trends and examining changes to current prices. To me QQQ is starting to act like volatility is on the rise, so I bought some premium. I'm hedging the position at points that confirm the higher vol. Some success today (but a day doesn't make a trend). We'll see about tomorrow.

Closing Position:
Long QQQ Sep 33 straddle (4X)
Short QQQ Sep 34 combo (2X)

DOA

2004-08-10T05:51:00.000-05:00

Nothing to lose. Except my vanity.

Opened a trade on the QQQ near the open (32.80). BOT the 33 straddle for 2.35 dr.

My volatility studies look like their bottoming, the market looks like it can go either way, and I want to go along for the ride.

I'm targeting 50-60 cents a week on this trade via some scalps & adjustments. With 6 weeks to go that makes my target about 3.30 for 95 cent profit. I'll be wrong on this trade if vol doesn't pop in the next couple weeks and the (already thin) air on this thing gets taken out further. Stop at 80 cent loss or 1.55 on the position.

Looked to scalp this thing; anticipated a quiet day and got it . Put in some orders to scalp 25% of my position with stock at 32.31 (buy) & 32.99 (sell). Missed 'em both. [Day range was 32.65-32.96, close at 32.80]

Tomorrow (actually later today) looking for a little more action. Fed makes irs move later probably raising rates again. This is damned if you do, damned if you don't time. Greenspan has to raise to be consistent with stated policy objectives. The markets want to see some inflation and oil is delivering it. But the election may hinge on at least the perception that the economy has found its stride. Working folks don't fair as well as (most) corporations when rates rise. Whatever the Fed does, I'm of course hoping that the markets make a big deal out of it.

Looking to scalp half my position by either trading stock or the combos at 33.35 or 32.00. Right now the downside vol is more than twice the upside (20% v. 9%). [I look at high/low changes from the previous day's close and a 30-day period to calculate my vols and project next day high/low. The target numbers for my scalping are 2 standard deviations for scalping half my deltas - in this case - if anyone's looking to see how I set my trade points.]

So let's see where it goes...