Coming back to optios. Need safer trades.

[OddTrader]

Quote from spindr0:

OK, we're on the same page now. Forget the call being sold. Howwwww-ever...

The key to the above statement is finding an undervalued below parity ITM put (where I'm stretching the meaning of parity to include the dividend). Buying the stock against that put is a way to capitalize on the hope that the put returns to fair value (or is achieved via exercise).

Suppose I saw some overvalued puts. I could sell a bunch of them naked and if an hour later the underlying was unchanged and the puts were back at fair value, I could take the profit.

That gain doesn't validate that selling naked puts is a good strategy or is safe. It just means that I took advantage of a market inefficiency.

"A smart strategy seeks to avoid catastrophic risk at all times, to profit by real or implied volatility explosions, and to limit time decay loss." --- Baird

 

[ivanbaj]

I found this:


So gamma scalping is just a standard delta neutral long vol play for which you pay your theta decay?

Here is a more general method that enables you to scalp volga as well as gamma.

Dynamically hedge your net position such that:

1. You are delta-neutral.
2. You are vega-neutral.
3. You have positive gamma.
4. You have positive volga.
5. You have gamma*volga > (vanna)^2.

This may be difficult to maintain, but if you can, then you will be at the bottom of a "profit well". It's a standard theorem in analysis that whatever directions spot and volatility move, together or independently, the value of your position will always increase. However it is not a risk-less profit because theta will lower the bottom of your well over time. On average it will keep you hedged against theta. If spot and volatility are changing rapidly, however, then you'll make a profit. If they are frozen, you'll make a loss. If you can build this position with mis-priced contracts, then you may be able to cut out most or even all of your theta and guarantee a profit!! (All this ignores trading costs, of course. It also depends on how you calculate your position vega, volga and vanna, since, strictly speaking, you need to do this with respect to a unique common indicator of volatility, not IVs.)


-------------------------

volga = dvega / dvol

vanna = dvega / dspot = ddelta / dvol

--------------

Gamma > 0 gives you a 1-dimensional well along the spot axis. Volga > 0 likewise along the volatility axis. The extra condition you ask about prevents leakage from the well in any other direction in the 2-d spot/volatility plane. (It guarantees a 2-d minimum.)

I dug out my old Analysis text-book from when I was an undergraduate. The book is "A Course Of Analysis" by E.G.Phillips, CUP 1962. The reference is section 10.5, pp256-259. See also "Partial Derivatives" by P.J.Hilton, Routledge & Kegan Paul, 1963, Chapter 4. Younger members of the forum may be able to point to more recent texts still in Print

 

[spindr0]

Quote from OddTrader:

"A smart strategy seeks to avoid catastrophic risk at all times, to profit by real or implied volatility explosions, and to limit time decay loss." --- Baird

I dub thee: Captain Obvious!

 

[HowardCohodas]

Quote from spindr0:

I dub thee: Captain Obvious!

That's a good thing. Sometimes even the obvious doesn't penetrate.

 

[donnap]

Quote from spindr0:

Here's a link to dividendium's explanation of their put protected dividend concept as well as an example:

http://www.dividendium.com/blog/index.php/how-can-we-invest-while-avoiding-losses/

Stock: SO
Stock Price: $34.59
Annual Dividend Yield: 4.86%

Option: SOWH
Option Ask: $5.80
Option Strike: $40.00
Option Expiration: 11/21/2008

Dividends Expected By Expiration: $0.42
Minimum Profit: ($40.00 + $0.42 – $34.59 – $5.80) $0.03
Max Loss Without Dividend: ($40.00 -$34.59 – $5.80) $-0.39
Percent Gain Needed For Profit: ($40.00 / $34.59 – 1) 15.6%

Here's their $64 question: "How can we invest while avoiding losses?"

SO is a low beta utility. That means its implied volatility is an IOU. IOW, it's in the 10-15 area. So a 15 IV stock needs to move 15.6% to make money? That's a pipe dream.

Rather than all of the smoke and mirrors, one could buy the equivalent OTM 40 strike call for maybe 15 cents. Save on the slippage and commissions and have the same lottery ticket.

They should be ashamed of pumping this stuff.

PS Note that the position can make money before 40 if the UL moves up quickly (timewise) since the put's delta is less than that of the UL and declines as price increases.

Yes, or an increase in IV, a higher than expected div. or a steep drop in interest rates could contribute to a potential profit here.

Note that this was written in early Aug. 2008 so that expiry is over 3 months away. The div. paid at the end of OCT. well over 2 months

The 3mo. t-bill yield was still over 1% back in Aug. 2008 Note that the investment is over 4000 per 100s + put.

As MTE pointed out, the interest rate discounted in the ITM put could easily account for any so-called mispricing or IOW for the likely return of .03 net of costs.

Indeed the 5.80 price looks on the high side as you might expect with the Ask price. I don't see any mispricing.

Interest rates did plunge during this trade and should have added to the put premium.

 

[spindr0]

Quote from donnap:

Yes, or an increase in IV, a higher than expected div. or a steep drop in interest rates could contribute to a potential profit here.

What's the likelihood they're going to raise the dividend more than a few cents? Or that interest rates would drop steeply in 3 months? Or that a low beta utility's IV would suddenly run up? Those are almost lottery ticket events.

My guess is that a utility is the perfect choice to demonstrate this "concept" (rolling eyes). They pay significantly higher dividends than most stocks, providing a sort of a faux appeal. "We found you a stock with a large dividend" (but we're not telling you that you're getting paid with your own money). And because the IV is low, the time premium is low, making it appear that the dividend is paying for the time premium (when in reality, the div is priced into the options) and that you have a low to no cost position that will make beaucoup bucks "IF" the underlying rises 15-20% by expiration (that pesky OTM call behavior). Problem is, this low beta utility has probably done this only a coupla times in 10 years.

And then there's the near zero risk concept... ignoring a minimum of 3 commissions and exit slippage. Yahh! This strategy is going to be a big wiener! - for the subscription seller

 

[donnap]

Quote from spindr0:

What's the likelihood they're going to raise the dividend more than a few cents? Or that interest rates would drop steeply in 3 months? Or that a low beta utility's IV would suddenly run up? Those are almost lottery ticket events.

My guess is that a utility is the perfect choice to demonstrate this "concept" (rolling eyes). They pay significantly higher dividends than most stocks, providing a sort of a faux appeal. "We found you a stock with a large dividend" (but we're not telling you that you're getting paid with your own money). And because the IV is low, the time premium is low, making it appear that the dividend is paying for the time premium (when in reality, the div is priced into the options) and that you have a low to no cost position that will make beaucoup bucks "IF" the underlying rises 15-20% by expiration (that pesky OTM call behavior). Problem is, this low beta utility has probably done this only a coupla times in 10 years.

And then there's the near zero risk concept... ignoring a minimum of 3 commissions and exit slippage. Yahh! This strategy is going to be a big wiener! - for the subscription seller

Yes, it's fubar. The fact that interest rates did plunge during the trade does not change the fact that it was a lottery ticket event - it was late 2008 after all.

That's what caught my eye. Their website provides the example from last period where interest rates were high enough to make these trades seem more attractive than they are.

IOW, they wouldn't provide a more recemt example because you can't do them for breakeven or better anymore.

You're right, they ought to be ashamed of themselves, but I doubt it.

 

[GTS]

Quote from spindr0:

Ummm, backspreads aren't exactly positions where the worst case scenario is a small loss (the OP's premise)

The worst case scenario in OP's premise was a small gain not loss:

Quote from iSeriesGuy:
From that original training, I distinctly remember there was one spread trade where, if it went against you, the worst case scenario was that you made a small profit.

 

[trefoil]

Quote from donnap:

Yes, it's fubar. The fact that interest rates did plunge during the trade does not change the fact that it was a lottery ticket event - it was late 2008 after all.

That's what caught my eye. Their website provides the example from last period where interest rates were high enough to make these trades seem more attractive than they are.

IOW, they wouldn't provide a more recemt example because you can't do them for breakeven or better anymore.

You're right, they ought to be ashamed of themselves, but I doubt it.

This was a fun bit of analysis to read. Good work fellas.

 

[spindr0]

----------------------------------------------------------------------
Quote from spindr0:

Ummm, backspreads aren't exactly positions where the worst case scenario is a small loss (the OP's premise)
-----------------------------------------------------------------------

Quote from GTS:

The worst case scenario in OP's premise was a small gain not loss:

Thank you for verifying what I said. Sometimes readers need more than one poster saying it before they believe it