Global Macro Trading Journal

[Ghost of Cutten]

Quote from ralph00:

Silver fell about $1 yesterday after the CME raised margin requirements. Used the drop and part of my profits from the FCX, EWH, and EWT puts to buy some bull call spreads (?) on SLV (bought the 45 call, sold the 50 call).

I think it's inevitable that the Hunt Brothers high of $50 gets taken out. Whether it happens this year or not is the question. These options (I bought across a few different expiry months) will pay off anywhere from 7:1 to 12:1 if the price hits $50.

I don't see the logic in shorting the $50 strike if you expect a huge rally. Call spreads are for when you expect a modest rally (e.g. 1 SD) over a specific timeframe, not when you expect a blowoff move.

Remember, one problem with a bull call spread is when you reach your price objective before expiry. You are then in a position that is effectively short a put, not what you want in an extended bull market move. And if you close out significantly before expiry in order to book your profit, you don't get the high R/R ratio. IMO you don't want to be short gamma in a blowoff spike up move with weeks left to expiry.

Sounds like you are very bullish and believe the timing is right. The correct position for that view is long some underlying, with a stop, and long some OTM calls 1-6 months out. Not long a bunch of call spreads.

 

[Ghost of Cutten]

Quote from Daal:

It seems to me that the likelihood of 2 hikes is pretty low so the trade has both good expectation and high chance to pay off(or at least a small loss on 1 hike). But its hard to quantify a risk with fed futures, in theory its 100% of my account because they could drop to 0 tomorrow

Yes but a good expectation and high chance to payoff, with some nasty tail risk, is not a justification for wagering at least 10% of net worth. To bet that high, really I think you need pretty much the perfect trade i.e. a very high win rate (e.g. 90%+), no tail risk, and a high R/R with some blue sky potential. This trade has none of those characteristics, if you are 100% correct then it's still only an 'ok' trade, it's not a potential home run, or a slam dunk that has hardly any chance of losing. And it has a nasty grey/black swan risk.

IMO you are over-egging the pudding here. A 10% bet should be the perfect trade, and have the downside strictly limited.

 

[Daal]

Quote from Ghost of Cutten:

. To bet that high, really I think you need pretty much the perfect trade i.e. a very high win rate (e.g. 90%+), no tail risk, and a high R/R with some blue sky potential.

Why?Are you using some kind of mathematical criteria like kelly criterion or something like that?

To me, its a matter of being comfortable with the drawdowns this position sizing will lead to and being far away from the Optimal F and kelly to make sure you dont go bust, if I run my numbers right my kelly here is around 60%.
I believe Soros build his fortune routinely making large bets like that when his confidence was high, I'm not as brilliant as him so I make sure I have a college degree and other sources of income(online gambling) in case I have a large drawdown one day

 

[Martinghoul]

Quote from Ghost of Cutten:
Remember, one problem with a bull call spread is when you reach your price objective before expiry. You are then in a position that is effectively short a put, not what you want in an extended bull market move. And if you close out significantly before expiry in order to book your profit, you don't get the high R/R ratio. IMO you don't want to be short gamma in a blowoff spike up move with weeks left to expiry.

This doesn't make sense to me. How can a call spread be effectively short a put? How can a call spread be short gamma? Finally, isn't being short a put a good position in an extended bull mkt? Moreover, if he's through his short strike and not happy unwinding the call spreads for some reason, all he needs to do is hedge the delta.

 

[ralph00]

Quote from Ghost of Cutten:

I don't see the logic in shorting the $50 strike if you expect a huge rally. Call spreads are for when you expect a modest rally (e.g. 1 SD) over a specific timeframe, not when you expect a blowoff move.

Remember, one problem with a bull call spread is when you reach your price objective before expiry. You are then in a position that is effectively short a put, not what you want in an extended bull market move. And if you close out significantly before expiry in order to book your profit, you don't get the high R/R ratio. IMO you don't want to be short gamma in a blowoff spike up move with weeks left to expiry.

Sounds like you are very bullish and believe the timing is right. The correct position for that view is long some underlying, with a stop, and long some OTM calls 1-6 months out. Not long a bunch of call spreads.

Not sure I understand. I don't see the problem in using the 50 call to partly finance the 45 call. Limits my upside to $5, but gets me in the trade for a lot cheaper. I'm not betting on a blowoff move in silver, just a continuation of the bull market as long as the Fed keeps printing. If SLV just goes to the low 40s by Memorial Day, I'll have doubled or tripled my money and then reassess whether to continue with the trade. If no move by Labor Day I'll lose a lot of premium.

If I reach my price objective ($5) before expiry, then I'm selling the spread. Why would I hold onto it when I could never make any more money.

If I sell early, yeah I don't get $5 on the spread, maybe just $3 - still an amazing roi. My experience with the FCX, EWH, and EWT puts were all similar spread trades, just puts instead of calls. They tripled (approx.) within weeks of buying. I didn't sit around waiting to collect the full monty, I thanked my lucky stars and covered all those suckers the morning after Japan fell 11%. Yeah, those might have been lucky, but I made my own luck, I think - I got in those trades when vol was miniscule, all the stocks had had major runs - the puts were so cheap, all it took was two or three weeks of just the slightest rocking in markets for them to explode in value.

Silver is different. I'm betting on a continuation of the run and the options aren't quite as cheap. I guess you've got to pay up when following the trend.

 

[pwrtrdr]

Quote from ralph00:
Could be good trade. Risk fed raises rates overnight. Slv gets crushed

Not sure I understand. I don't see the problem in using the 50 call to partly finance the 45 call. Limits my upside to $5, but gets me in the trade for a lot cheaper. I'm not betting on a blowoff move in silver, just a continuation of the bull market as long as the Fed keeps printing. If SLV just goes to the low 40s by Memorial Day, I'll have doubled or tripled my money and then reassess whether to continue with the trade. If no move by Labor Day I'll lose a lot of premium.

If I reach my price objective ($5) before expiry, then I'm selling the spread. Why would I hold onto it when I could never make any more money.

If I sell early, yeah I don't get $5 on the spread, maybe just $3 - still an amazing roi. My experience with the FCX, EWH, and EWT puts were all similar spread trades, just puts instead of calls. They tripled (approx.) within weeks of buying. I didn't sit around waiting to collect the full monty, I thanked my lucky stars and covered all those suckers the morning after Japan fell 11%. Yeah, those might have been lucky, but I made my own luck, I think - I got in those trades when vol was miniscule, all the stocks had had major runs - the puts were so cheap, all it took was two or three weeks of just the slightest rocking in markets for them to explode in value.

Silver is different. I'm betting on a continuation of the run and the options aren't quite as cheap. I guess you've got to pay up when following the trend.

 

[Ghost of Cutten]

Quote from Martinghoul:

This doesn't make sense to me. How can a call spread be effectively short a put? How can a call spread be short gamma? Finally, isn't being short a put a good position in an extended bull mkt? Moreover, if he's through his short strike and not happy unwinding the call spreads for some reason, all he needs to do is hedge the delta.

When the spread is near the upper strike ($50 in this case) with a few days or weeks to expiry, your upside is small, and you have close to $5 (10%) risk per contract. That's similar to a short put (i.e. short gamma), except that you don't get totally screwed if it falls more than $5.

If the scenario ralph is expecting to occur, in fact plays out, then IMO he is much better off just being long the $45 calls. A call spread sacrifices larger upside in order to pay a bit less premium. Sacrificing extreme upside is the last thing you want to do in a rampaging bull market - in this case, if ralph's trade thesis is correct, then the slightly higher premium should easily be worth paying.

If a slow 6 month drift up is expected, then that makes more sense. But commodity markets tend to experience rising volatility as the price increases in a bull market. I would be surprised if we approach all-time highs in a commodity like silver without seeing a few wild and crazy moves.

 

[ralph00]

The wild and crazy move will be getting to $50! Silver is only at $38. A move to $50 in 2011 would be like 30% over the next 9 months on top of the run we've already had. No, I think $50 this year will be wet dream enough for me. If it goes significantly past that, kudos to whoever is long past that point.

 

[Martinghoul]

Quote from Ghost of Cutten:
When the spread is near the upper strike ($50 in this case) with a few days or weeks to expiry, your upside is small, and you have close to $5 (10%) risk per contract. That's similar to a short put (i.e. short gamma), except that you don't get totally screwed if it falls more than $5.

If the scenario ralph is expecting to occur, in fact plays out, then IMO he is much better off just being long the $45 calls. A call spread sacrifices larger upside in order to pay a bit less premium. Sacrificing extreme upside is the last thing you want to do in a rampaging bull market - in this case, if ralph's trade thesis is correct, then the slightly higher premium should easily be worth paying.

If a slow 6 month drift up is expected, then that makes more sense. But commodity markets tend to experience rising volatility as the price increases in a bull market. I would be surprised if we approach all-time highs in a commodity like silver without seeing a few wild and crazy moves.

Again, it's just a matter of hedging the delta at the short strike (or at the midpoint), if it ever gets there.

As to the payout on the call spreads vs the calls, yes, you're sacrificing larger upside, but if you're able to buy the call spreads much cheaper due to skew, the payout might be well worth it (i.e. if the larger upside of naked calls requires significantly more premium). The point is that without seeing how much the naked call is worth vs the call spread, you can't make a judgement about what's optimal. My point is that the two trades are different in terms of payout AND upfront cost and both might be viable.

 

[Ghost of Cutten]

Quote from Martinghoul:

Again, it's just a matter of hedging the delta at the short strike (or at the midpoint), if it ever gets there.

As to the payout on the call spreads vs the calls, yes, you're sacrificing larger upside, but if you're able to buy the call spreads much cheaper due to skew, the payout might be well worth it (i.e. if the larger upside of naked calls requires significantly more premium). The point is that without seeing how much the naked call is worth vs the call spread, you can't make a judgement about what's optimal. My point is that the two trades are different in terms of payout AND upfront cost and both might be viable.

Delta hedging has the possibility for substantial loss from whipsaws or gap moves. And since it's not a cash settled contract, the spread itself would have substantial pin risk if the market is near $50 at expiry.

Commodity bull markets tend to experience rising volatility and event risk as prices increase, due to the compulsion to buy on the part of commodity consumers. In that respect, they resemble inverted stock market crashes. That is exactly the kind of wild and crazy market environment where things like trying to delta hedge, liquidate options spreads without getting raped on the bid/offer spread, and trying to manage the risks of being exercised during a delivery squeeze become problematic. Just look at a market like wheat in spring 2008 for an example. The benefit of being only long options/futures, without any short strikes, is significant in those kind of situations. It is almost certainly worth more than whatever small premium you could collect from shorting the $50 calls.

If you think about it, what is the worst possible market situation to short a call in? A volatile runaway bull market. What is ralph betting on? If he thinks silver will have a gentle drift up to $50 by summer, well I would propose that he goes and looks at past commodity bull markets to get a better idea of how likely a slow steady rally is. Far more typical is for the move to end with large price spikes, normally you get a daily move of historic proportions, that is the largest in % terms for the last few years, before the rally comes to an end. I don't see how the premium collected is large enough to compensate for capping your gains in that kind of situation.