Betting on unflattening of the ATM IV curve

[MrMuppet]

Would you mind sharing where do you think this edge comes from? In other words, who’s creating these inefficiencies you are exploiting? I was under impression that options are very efficiently priced and by the brightest firms. Ate you competing against them or do you find yourself joining them (against buy-side flows that create these inefficiencies)? Who’s on the other side of your trade, if it’s not the MMs?

#1 source of edge is inventory constraints. When you're loaded to the brim because you just soaked up a big ticket, you skew your quote. If you keep quoting at "optimal" price because your model said this is it, you'll find your self in a conversation with your clearer pretty often.

If no other MM is around and you bought a truckload of front month vega...well you'll quote lower than optimal and create a wonky surface. And that's where retail has edge.

So it's NOT the buyside firms you have to frontrun with their big tickets, it's the MMs that are at inventory limit that you can exploit, kinda.

It certainly is always best to understand the underlying concepts since form will change over time while concepts and/or processes often last longer then it's form in present state.

When you (at least i did) start out you tend to think a certain combination contains edge, so you spend (too) much time thinking you should use a 2-3-1 or a 1-2-1 butterfly for example. At least I never found something herein, but this changed when I viewed options/combinations not in isolation, but more in a strategic way. For example, setting them up over series depending upon certain movement of the underlying. These things are difficult to backtest, which is probably a blessing.

The most important thing for retail is trading options chains that have high vol of vol, really.

I see too many guys fumble around with options on 50$ big board stocks. Dude, when your delta neutral long call trades at 16 IV and has a vega of 10cts, how much do you think you'll gonna win or lose in vol when it trades at 18 IV given the fact that you donate 2$ halfturn to your broker?

In order for retail to make any meaningful P/L in vol, you need tripple digit IVs and vega in the dollar ranges. Instead of 10 5$ flys in BAC, trade 1 100$ fly in TSLA.

If you don't have specific 2nd or 3rd order edge like spot/vol correlation, directional edge or 5ct comission rates, don't trade index vol. We're trading in the 15s an it's barely doing anything.

You need vol to move in order to make dosh from it. As retail you don't even want to look at 30 calendars that are less than 10 vols apart and where the individual option has less than 5$ vega, really.

 

[qlai]

It’s interesting to spend a little time on philosophy but it doesn’t really matter to my bottom line.

Thanks. It’s not really a philosophical question because inefficiencies in an otherwise very efficient market are oftentimes mean hidden dangers. I am sure you know what you are doing, but I was just curious if you could tell the difference between the two situations.

 

[LM3886]

Great discussion! Out of curiosity, what's the typical scope of an MM's inventory? A couple of underlyings, or a few tenors/strikes of a single underlying?

 

[MrMuppet]

Great discussion! Out of curiosity, what's the typical scope of an MM's inventory? A couple of underlyings, or a few tenors/strikes of a single underlying?

It depends. There are specialized shops like flowtraders or optiver that basically quote anything they have edge in. They can have hundreds of thousands of vega in total but they move around their surfaces a lot, especially in illiquid names

Then there are the big internalizers who trade stocks, futures, fx, options and exotics into a so called internal market. These guys are so big they don't care when they eat a huge order because they can solve the price not just against other options but against synthetic products they run in their portfolio. These guys are the axes in big board stocks and it's not worth trading against them unless a name really blows up.