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

[Abundance Magnet]

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.

Thanks Sig.

To clarify, I have read McMillan, Sinclair, Bulkowski, etc... I have invested in my trading book library and am happy to buy more books. I had a Q regarding Hull because there are currently 10 editions of it and would prefer to buy a version that has thicker paper stock, rather than the rice paper one. Hopefully, that is the 10th edition.

My observations thus far are that:
1) FI's like IB do not release their formulas on how they derive their greeks. It is their proprietary formula (so they've told me). Hence, i've seen different values by different platforms for the same greek (same option, underlying, etc...)
- if that is the case, it is difficult make a decision based on 'x' when 'x' is different from platform to platform. i.e. if my buying or selling decision is based on X, one platform might give me the buy signal, and the other would be to hold or sell.
- for me, and this is the biggest realisation in writing this post. It's the lack of consistency and concreteness in the greeks that led me to being disillusioned about it all. If the #s are unreliable/inconsistent anyway... why bother mastering it? why not invest my time and energy in mastering something that has more reliable results?

2) IV is the biggest determinant in price and IV cannot be properly quantified. Rather, it's understanding how IV influences the greeks that i've found to be most helpful in my trading.
3) the MM do not necessarily price their options based on the greeks. It's a major influencer, but not the sole influencer. Rather, it's supply-demand, and balancing their books. they use the greeks as a guideline to price things competitively. But if they take a position over there, they will take the offsetting position here because it makes financial sense to them.

there are more observations, but those are the 3 that jump to me. As a trader, my results are based on using my top talents and getting help in the areas that I am weaker in. Currently, I am a directional trader and am happy with my journey thus far. Spreads and non-directional strategies... that's what I'm interested in learning more about. More out of interest and the possibility off adding it as an additional tool.

 

[beerntrading]

As a former professional pilot, I know for sure that every pilot knows exactly how every part of the airplane they fly works.

You'd probably appreciate me taking this a step further. Any driver may well know that smelling gas in the exhaust isn't ideal, but knowing that means your car is running rich will factor into the marginal performance of the best drivers (or far more dramatically as a pilot while your engine keeps running...or not). Knowing when volatility is rich or "lean", by the same token, should impact your trading.

When your talking about the margins of options trading, picking up a few fractions of a percent here or there consistently makes an equally dramatic difference to your trading.

1) FI's like IB do not release their formulas on how they derive their greeks. It is their proprietary formula (so they've told me). Hence, i've seen different values by different platforms for the same greek (same option, underlying, etc...)

And...to somewhat contradict what I've just said, how someone else calculates something is less important than how consistent they are in this calculation as a relative value. A more precise trading model will not improve accuracy anymore than adding 0s after the decimal point will make a larger number (and for the same reason).

To directly answer the question in the title, you're not getting out of a condor in the type of volatility scenario your lay out. Period. This is as likely to save you from yourself as hamper your trading.

For a good example, look at PM / MO on 7/28/17. Some context: the FDA announced, during market hours, their intent to explore limits on per-cigarette nicotine content to non-addictive levels. MO is Phillip Morris's domestic sales, PM is the international. It took nearly 45 mins before the news drop for the volatility to really hit, but then it did with a vengence. The ATM calls with model values somewhere around $1.25 were trading with a spread of better than $6. I personally was trading the obvious PM rebound, and had a very good idea of what I was will to pay (or take) on either side of that spread. I was personally able to close it by $4 without ever getting a fill before I got to prices I was not confident would be winners (and I don't believe there was any activity elsewhere on the chains while I was resting orders). After a few hours, the rebound came back, volatility settled, and I got out of the call position I had for not much more than the IV from the previous day. Moral of the story--no fill on single leg, means no fill on condor. Had you panicked, you may well have taken a bad price, and since you were locked in your position, you may well come out unscathed in spite of yourself.

Edit: For clarity sake, I think the MO news was about 10:35am on a tweet from the FDA Tobacco account....but that's just my recollection, so don't hold me to it.

 

[Abundance Magnet]

cool. love it. love being stretched. It's the best way to grow.

 

[ironchef]

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

I think you missed the key points TheBigShort tried to convey to you: You don't have to know how to derive B-S equations from first principle. You don't have to know differential equations and calculus but you sure need to know the basic assumptions that go into the formula and the interplays between those assumptions. You need to know the no arbitrage principle and where it breaks down, you need to understand IV and the non-normal distribution, the tails.... Also, the concepts of convexity and the asymmetric nature of options.

Folks here were kind enough to teach me all that and then some. Yes, I am a newbie, a retail and still learning. But I do derive the bulk of my income from trading - yes, I admit, I am like a monkey throwing darts at the option chains in this bull market and thinking I am an expert.

Best wishes to you and good luck.

 

[Abundance Magnet]

I think you missed the key points TheBigShort tried to convey to you: You don't have to know how to derive B-S equations from first principle. You don't have to know differential equations and calculus but you sure need to know the basic assumptions that go into the formula and the interplays between those assumptions. You need to know the no arbitrage principle and where it breaks down, you need to understand IV and the non-normal distribution, the tails.... Also, the concepts of convexity and the asymmetric nature of options.

Folks here were kind enough to taught me all that and then some. Yes, I am a newbie, a retail and still learning. But I do derive the bulk of my income from trading - yes, I admit, I am like a monkey throwing darts at the option chains in this bull market and thinking I am an expert.

Best wishes to you and good luck.

Thanks. That is what I am trying to understand: the concepts, the assumptions, weaknesses in the assumptions and concepts, etc.. Which goes back to my wanting to understand things to apply them. I thought the car driving analogy was a good one, but that seemed to take the conversation on a different tangent.... Thanks for all your supportive feedback.

 

[ironchef]

For a good example, look at PM / MO on 7/28/17. Some context: the FDA announced, during market hours, their intent to explore limits on per-cigarette nicotine content to non-addictive levels. MO is Phillip Morris's domestic sales, PM is the international. It took nearly 45 mins before the news drop for the volatility to really hit, but then it did with a vengence. The ATM calls with model values somewhere around $1.25 were trading with a spread of better than $6. I personally was trading the obvious PM rebound, and had a very good idea of what I was will to pay (or take) on either side of that spread. I was personally able to close it by $4 without ever getting a fill before I got to prices I was not confident would be winners (and I don't believe there was any activity elsewhere on the chains while I was resting orders). After a few hours, the rebound came back, volatility settled, and I got out of the call position I had for not much more than the IV from the previous day. Moral of the story--no fill on single leg, means no fill on condor. Had you panicked, you may well have taken a bad price, and since you were locked in your position, you may well come out unscathed in spite of yourself.

Edit: For clarity sake, I think the MO news was about 10:35am on a tweet from the FDA Tobacco account....but that's just my recollection, so don't hold me to it.

May I digress. I also trade PM, both the underlying and options, underlying is intermediate and long term holding but options short and intermediate terms, so would like your opinion on PM: short, intermediate and long term if you don't mind.

Thanks.

 

[beerntrading]

May I digress. I also trade PM, both the underlying and options, underlying is intermediate and long term holding but options short and intermediate terms, so would like your opinion on PM: short, intermediate and long term if you don't mind.

Thanks.

I owned MO from 2009 until early this year. So, I know it better, but I still follow PM some. As far as trading, it's rare I'll do anything on them except pick off good longs and shorts when the news takes hold (been over enough regulatory speed bumps in my time owning MO to be confident how the market is likely to digest news). They're pretty much institutional behemoths ruled by their dividends--so pretty boring unless you catch the news in time to trade them...I've traded neither since selling MO.

As far as longer term, my reasoning for dumping it was pretty simple, that 7/28/17 price move gave MO a 10% handicap against PM for the year, but PM was the one that under performed in the second half of 2017. The two together provide a nice bellwether for regulatory vs. market (and health) related risks to their profits. To that end, I think the tide may be turning on a global level to where rising health awareness is likely to offset price increases on what has been a very inelastic demand pricing model. I also don't think that MO trades at the regulatory / litigation discount it once did--I think it's widely accepted you're unlikely to get a jury seated that will make a precedent-setting award; whereas this wasn't the case 5 or 8 years ago. So it's more about known risk being priced in than unknown risk being heavily discounted.

I don't really like either for retirement-horizon holding term that dividend stocks like this should be. It's not so much that I think they're unfairly valued as I see equally good opportunities without the singular exposure to a globally declining market. Also, vaping is a paradigm shift unseen in the history of tobacco--while I have no doubt in the ability of PM and MO to innovate through ingenuity or brute force, this kind of shift is one that can fill in economic moats completely. I think the hold forever and reinvest the dividend space that a value-dividend stock like this should occupy has better opportunities.
The one that may get my attention is a safe dividend on a beaten down stock. If PM's dividend (or MO's) approaches 7 or 7.5%, it is probably too tempting to ignore. That would imply a nice upside for months or a year, IMO.

 

[ironchef]

I owned MO from 2009 until early this year. So, I know it better, but I still follow PM some. As far as trading, it's rare I'll do anything on them except pick off good longs and shorts when the news takes hold (been over enough regulatory speed bumps in my time owning MO to be confident how the market is likely to digest news). They're pretty much institutional behemoths ruled by their dividends--so pretty boring unless you catch the news in time to trade them...I've traded neither since selling MO.

As far as longer term, my reasoning for dumping it was pretty simple, that 7/28/17 price move gave MO a 10% handicap against PM for the year, but PM was the one that under performed in the second half of 2017. The two together provide a nice bellwether for regulatory vs. market (and health) related risks to their profits. To that end, I think the tide may be turning on a global level to where rising health awareness is likely to offset price increases on what has been a very inelastic demand pricing model. I also don't think that MO trades at the regulatory / litigation discount it once did--I think it's widely accepted you're unlikely to get a jury seated that will make a precedent-setting award; whereas this wasn't the case 5 or 8 years ago. So it's more about known risk being priced in than unknown risk being heavily discounted.

I don't really like either for retirement-horizon holding term that dividend stocks like this should be. It's not so much that I think they're unfairly valued as I see equally good opportunities without the singular exposure to a globally declining market. Also, vaping is a paradigm shift unseen in the history of tobacco--while I have no doubt in the ability of PM and MO to innovate through ingenuity or brute force, this kind of shift is one that can fill in economic moats completely. I think the hold forever and reinvest the dividend space that a value-dividend stock like this should occupy has better opportunities.
The one that may get my attention is a safe dividend on a beaten down stock. If PM's dividend (or MO's) approaches 7 or 7.5%, it is probably too tempting to ignore. That would imply a nice upside for months or a year, IMO.

Thank you.

PM bounces around a base of ~$80 for the last 5 years. With a dividend of ~5%-6%, it was quite profitable to hold and trade options around that base. That is, until last year when it peaked and then fell from $120 back to $80 and I couldn't adjust. I am profitable in aggregate but am debating whether to call it a day and closing everything out.

The outlook for cigarettes is very poor but shareholders hope PM can reinvent itself.

Regards,