Credit - debit spreads and ICs - what happened during the vix crash?

[Abundance Magnet]

So I've read and heard about how spreads and especially ICs protect by limiting the loss on the trade. However, my observations have been that in times of high volatility the cost for both the calls and the puts go up, plus the spread widens dramatically. If so, then wouldn't the protection provided by the spreads and ICs be limited?
what happened for those that were in these types of trades? Was the max loss still the width of the spread? I suspect not, and that the max loss is actually the cost to close the trades regardless of the spreads... Thoughts?

 

[TheBigShort]

The protection is truly there. You will not lose more than the width of the short/long strikes minus the credit received. I see you are asking a lot of questions on ET (which is a good thing), but I think you should pick up a few books/papers to give you a better understanding of the vol space. I found this to be a great line to take: read in order

Natenberg - option volatility and pricing
hull - options futures and other derivatives
Sinclair - Volatility trading (collin benett also did a similar book "trading volatility")
Rebonato - volatility and correlation
Taleb - Dynamic hedging.

This should keep you busy for the next 3 months .

 

[Abundance Magnet]

The protection is truly there. You will not lose more than the width of the short/long strikes minus the credit received. I see you are asking a lot of questions on ET (which is a good thing), but I think you should pick up a few books/papers to give you a better understanding of the vol space. I found this to be a great line to take: read in order

Natenberg - option volatility and pricing
hull - options futures and other derivatives
Sinclair - Volatility trading (collin benett also did a similar book "trading volatility")
Rebonato - volatility and correlation
Taleb - Dynamic hedging.

This should keep you busy for the next 3 months .

Thanks. I've read a bunch, and continue to do so. Ive read McMillan, reading Sinclair now. Sinclair is a bit too math heavy for my liking. I can do it but would need a supporting text to practice the equations. Ive read a bunch of others as well. Over the years, I've learned/observed that there are the good texts and the texts by those who expound their limiting beliefs about the market and trading. My observation is that there is theoretical practice, and then there is real life and what actually happens in real life. I trade live for my current strategies and I paper trade strategies I am working on. The challenge with paper is that I can only forward test those strats based on the current market conditions. My mind then wonders about the past scenarios which led me to questions like this one.

So... Is your answer based on theory, or real life? If so, how in the world did some of these volatility /vix selling hedge funds collapse if it is so easy to hedge it with a spread or IC? I would love to get real life confirmation by someone. As well, how did the brokers respond to ppl with spreads? I imagine that part of the spike was due to brokers like IB changing margin requirements and auto liquidating ppl... How did this affect ppl with spreads and ICs?

Lots of questions I know... Grateful for your answers...

 

[JSOP]

Thanks. I've read a bunch, and continue to do so. Ive read McMillan, reading Sinclair now. Sinclair is a bit too math heavy for my liking. I can do it but would need a supporting text to practice the equations. Ive read a bunch of others as well. Over the years, I've learned/observed that there are the good texts and the texts by those who expound their limiting beliefs about the market and trading. My observation is that there is theoretical practice, and then there is real life and what actually happens in real life. I trade live for my current strategies and I paper trade strategies I am working on. The challenge with paper is that I can only forward test those strats based on the current market conditions. My mind then wonders about the past scenarios which led me to questions like this one.

So... Is your answer based on theory, or real life? If so, how in the world did some of these volatility /vix selling hedge funds collapse if it is so easy to hedge it with a spread or IC? I would love to get real life confirmation by someone. As well, how did the brokers respond to ppl with spreads? I imagine that part of the spike was due to brokers like IB changing margin requirements and auto liquidating ppl... How did this affect ppl with spreads and ICs?

Lots of questions I know... Grateful for your answers...

Hull is also good. Introduces to you the whole spectrum of derivative products out there. Although it's mostly for institutions, but it opens your eyes to all the possibilities like credit swaps showcased in that movie "The Big Short".

For the real life stuff, trade in your real trading account and you will know.

 

[TheBigShort]

Sinclair is a bit too math heavy for my liking.

I personally believe a strong fundamental knowledge of math and stats is mandatory in trading options. So you most definitely wan't to brush up if you wan't to take trading that much further. An author like Sinclair would not have included it if it wasn't needed.

So... Is your answer based on theory, or real life? If so, how in the world did some of these volatility /vix selling hedge funds collapse if it is so easy to hedge it with a spread or IC?

There is really only one reason why people blow up and that is leverage. That is a real life answer not a theoretical answer. When you are levered 10x on a short vol position and you get a large sharp move down....kaboom.

 

[Abundance Magnet]

Hull is also good. Introduces to you the whole spectrum of derivative products out there. Although it's mostly for institutions, but it opens your eyes to all the possibilities like credit swaps showcased in that movie "The Big Short".

For the real life stuff, trade in your real trading account and you will know.

Interesting.... Looking I to the hull book. 10 editions so far, that's nuts. Would be nice to k ow what is different with different editions. Read one review that a certain edition uses super thin paper. I hate that. I have the encyclopedia of chart patterns book and flipping those rice paper this pages is annoying.

I believe the most important thing to glean is how options work (which is my perspective in reading the books). Identifying the trends, relationships, limitations, etc... Similar to driving a car. Don't need to know how all the inner workings of the car work from an engineering perspective. Rather to be a great driver, know how to drive well, assess the environment, assess the other drivers, and understand your vehicles strengths, weaknesses and limitations.

 

[JSOP]

Interesting.... Looking I to the hull book. 10 editions so far, that's nuts. Would be nice to k ow what is different with different editions. Read one review that a certain edition uses super thin paper. I hate that. I have the encyclopedia of chart patterns book and flipping those rice paper this pages is annoying.

I believe the most important thing to glean is how options work (which is my perspective in reading the books). Identifying the trends, relationships, limitations, etc... Similar to driving a car. Don't need to know how all the inner workings of the car work from an engineering perspective. Rather to be a great driver, know how to drive well, assess the environment, assess the other drivers, and understand your vehicles strengths, weaknesses and limitations.

Options trade differently as you will discover; they do not follow certain chart patterns like the technical analysis that is usually performed for other instruments like stocks because the price of an option is calculated by various factors such as implied volatility, duration of time to expiration and etc.

 

[TheBigShort]

Don't need to know how all the inner workings of the car work from an engineering perspective.

If I recall correctly, I recently saw a thread where you were curious about call options and how they react to spot.
A passionate driver will want to learn how and why her car works just from her love of the car/driving.
At the end of the day if you are going to become a successful option trader you need to understand the product from a fundamental ("engineering") level. But hey, what do I know....

 

[Abundance Magnet]

If I recall correctly, I recently saw a thread where you were curious about call options and how they react to spot.
A passionate driver will want to learn how and why her car works just from her love of the car/driving.
At the end of the day if you are going to become a successful option trader you need to understand the product from a fundamental ("engineering") level. But hey, what do I know....

If that's what works for you, wonderful. Personally, I doubt every passionate driver has disassembled their car or studied all the engineering mechanics of their car. We are all on our journey and pursue it in the way that works best for us. I'm happy you're on your passionate path. As am I. I love what I do.

Cheers To your abundance

 

[Sig]

If that's what works for you, wonderful. Personally, I doubt every passionate driver has disassembled their car or studied all the engineering mechanics of their car. We are all on our journey and pursue it in the way that works best for us. I'm happy you're on your passionate path. As am I. I love what I do.

Cheers To your abundance

Not to torture the analogy too much, I'd say most professional racecar drivers do indeed know the engineering behind how their cars work. As a former professional pilot, I know for sure that every pilot knows exactly how every part of the airplane they fly works. Something to consider, there's a counterparty to every option trade you make. That counterparty most probably fully understands options at the fundamental level. What's your edge on them? As the old saying goes, if you don't see the sucker when you look around the poker table....you're the sucker! Just to emphasize, you are asking great questions and clearly very intellectually curious so just trying to encourage you to take the deep dive into the hard stuff, not discourage you.