Hedging ratios for vega neutrality/vomma trading

Even if there is edge in higher order greeks, that edge goes away after considering transaction cost (both commissions and wide b/a), high tax imposed on short term capital gains and cost of leverage.

In general Mr. Muppet post is good one where he points out the folly of the most option educators.
 
newwurldmn said:
Lots of people look at the second and third order greeks. Lots of people look at cross greeks as well. But they generally run very large books where those effects are meaningfully monetizable in the scope of their pnl. An exotics desk may look at vomma while pricing a 10 year insurance structure that has billions in notional. Vomma might explain a few million dollars of their pnl.

Other than an intuitive concept, I never understood why a retail trader would worry about greeks beyond Gamma, Theta, Vega, and Delta. Everything else can be modeled by shocking your book.
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Thing is, while I qualify as a retail, my book and my setup probably isn't. Meaning I'm not trading via IB or ToS.
I don't care about Joe Public because he loses anyways. I care about 2nd and 3rd order greeks because it's easier to understand the behaviour of my book when it cointains 20+ strikes over 3+ maturities and different quantities.

I'd rather have a quick look at some numbers than to disect my entire position to figure out were my leaks are. +vanna? so I'm either short puts or long calls -> a look at vomma...which is negative, so I'm short puts. Way faster, way more convenient and a lot better when swords are swinging.

As everyone knows, options portfolios are multidimensional and should be treated as such. Sure, the average vertical trader doesn't care, but as soon as you go beyond that, you should IMO know were your risks are.

When I started, I sold an OTM put 30 days out and hedged delta neutral with the underlying. During the next couple of days market creeped up, volatility goes down. Even though everything went as expected,I lost money. Why and how? It was such a simple position and it took me days to figure it out. When volatility went down, the put lost so many deltas that I was massively overhedged and lost more in the UL than I made from theta and vol.

I just did not account for that. And the more I trade, the more useful options traits I figure out...for me it was worth it to go into the rabbit hole
 
srinir said:
Even if there is edge in higher order greeks, that edge goes away after considering transaction cost (both commissions and wide b/a), high tax imposed on short term capital gains and cost of leverage.

In general Mr. Muppet post is good one where he points out the folly of the most option educators.
More...


There is no edge in higher order greeks. Higher order greeks help you to manage a position that conserves the edge you gained from selling high/buying low.

Let's say you sold a call 10cts over fair value, how are you going to realize your profit? Well you can say "I wait till another guy wants to buy at fair value"...what if the market moves until then? "well I just hedge delta"...what if time goes by, skew changes, volatility goes up, yada, yada??

"well...ermm I have no idea, I just hope that somebody will take that darn thing out of my hand before that happens"


Thing is, during pit days a lot of pricing could be done with synthetics or no arb criteria. Today good luck with free calendars or butterflies.

I look at the butterfly curve, 20 delta skew, ATM straddle values, etc. just to see were vol is cheap or rich. Flow helps, too, like is the combo traded (puts sold/calls bought or vice versa), is the fly traded (body sold, wings bought), is vol traded (puts&calls bought or sold).
This is how I trade and how I find edge....not how I manage positions. I want to have a position that is as neutral as possible so I can realize the most of my edge.

And the better I manage not to lose money due to an idiotic position, the better, so I make sure I'm as neutral as possible while I buy cheap inventory (Vega) that I can sell out later again.

I don't care were the stock is trading, I don't have an opionion, I have my model that tells me what and how much to buy, the rest is discretion.
 
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MrMuppet said:
Thing is, while I qualify as a retail, my book and my setup probably isn't. Meaning I'm not trading via IB or ToS.
I don't care about Joe Public because he loses anyways. I care about 2nd and 3rd order greeks because it's easier to understand the behaviour of my book when it cointains 20+ strikes over 3+ maturities and different quantities.

I'd rather have a quick look at some numbers than to disect my entire position to figure out were my leaks are. +vanna? so I'm either short puts or long calls -> a look at vomma...which is negative, so I'm short puts. Way faster, way more convenient and a lot better when swords are swinging.

As everyone knows, options portfolios are multidimensional and should be treated as such. Sure, the average vertical trader doesn't care, but as soon as you go beyond that, you should IMO know were your risks are.

When I started, I sold an OTM put 30 days out and hedged delta neutral with the underlying. During the next couple of days market creeped up, volatility goes down. Even though everything went as expected,I lost money. Why and how? It was such a simple position and it took me days to figure it out. When volatility went down, the put lost so many deltas that I was massively overhedged and lost more in the UL than I made from theta and vol.

I just did not account for that. And the more I trade, the more useful options traits I figure out...for me it was worth it to go into the rabbit hole
More...
What software do you use to view your risk?
 
MrMuppet said:
There is no edge in higher order greeks. Higher order greeks help you to manage a position that conserves the edge you gained from selling high/buying low.

Let's say you sold a call 10cts over fair value, how are you going to realize your profit? Well you can say "I wait till another guy wants to buy at fair value"...what if the market moves until then? "well I just hedge delta"...what if time goes by, skew changes, volatility goes up, yada, yada??

"well...ermm I have no idea, I just hope that somebody will take that darn thing out of my hand before that happens"
More...


All i am saying is marginal benefit of managing position between by taking into account higher order of greeks vs just managing the position by looking at delta, gamma, theta and vega goes away after taking into transaction cost and step function because of smaller size of the retail.
 
srinir said:
All i am saying is marginal benefit of managing position between by taking into account higher order of greeks vs just managing the position by looking at delta, gamma, theta and vega goes away after taking into transaction cost and step function because of smaller size of the retail.
More...

You're probably right. I always forget that retailers pay way too much commission for that kind of trading.
 
MrMuppet said:
Thing is, while I qualify as a retail, my book and my setup probably isn't. Meaning I'm not trading via IB or ToS.
I don't care about Joe Public because he loses anyways. I care about 2nd and 3rd order greeks because it's easier to understand the behaviour of my book when it cointains 20+ strikes over 3+ maturities and different quantities.

I'd rather have a quick look at some numbers than to disect my entire position to figure out were my leaks are. +vanna? so I'm either short puts or long calls -> a look at vomma...which is negative, so I'm short puts. Way faster, way more convenient and a lot better when swords are swinging.

As everyone knows, options portfolios are multidimensional and should be treated as such. Sure, the average vertical trader doesn't care, but as soon as you go beyond that, you should IMO know were your risks are.

When I started, I sold an OTM put 30 days out and hedged delta neutral with the underlying. During the next couple of days market creeped up, volatility goes down. Even though everything went as expected,I lost money. Why and how? It was such a simple position and it took me days to figure it out. When volatility went down, the put lost so many deltas that I was massively overhedged and lost more in the UL than I made from theta and vol.

I just did not account for that. And the more I trade, the more useful options traits I figure out...for me it was worth it to go into the rabbit hole
More...

If you need it, then you need it. Most people (including professional vol traders don’t.)

If your example took days for you to figure out then formalizing the second order Greeks isn’t your solution. It’s an intuitive understanding of how options work. you learned something in that analysis. Next time you will be thoughtful about this risk factor when you put on a similar trade. And next time you will encounter another risk factor that will take days for you to understand. That’s how the learning works.

I’m learning everyday and I’ve been trading vol for almost 20 years. I bet @sle will say the same thing (and he knows a lot more about vol trading than I).
 
Having jumped into "trend exploitation" in 2018, it means I've kinda put-to-bed my options work. But I was reminded last night of something I did that fits into the discussion right here: I took the Black Scholes Merton PDE and deconstructed it into what in current vernacular is a Profit Attribution set. Assuming a 6.5-hour look-ahead, I shocked the inventory through ±1% "overnight" moves, distinguished by expiry. (In a sweet little graphical move, I colored the front expiry bright red, then red-orange, orange, yellow, yellow-green, green..... as a reflection of DTE on market-move impacts.) This told me by color (red=hottest) what positions needed addressing most, and on which side of the market -- thus, I had a battle-plan for every market swing. Sweet, that.

The thing is, theta was fixed for 6.5 hours, vega was set to an inverse of the price move percent (so, a 1% pop in price → -1.0 in vol), delta was preset in quarter-point moves from -1.0% to +1.0%, and gamma matched delta. Most of the time, this thing had impacts on net liq. down scary well -- when it was off, it was for vol reasons, but in ways to be completely expected -- so that fact that I had *any* vol effect in there put me way ahead of any other approximator I'd found.

Upshot is, ye olde BSM PDE can get you a good bit closer to where are aiming. I just googled Black Scholes Merton PDE Profit Attribution, and saw a bunch of familiar cites, so.....
Best Wishes!
 
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