How to realize buying cheap vol

[jordanwrong]

Today I put on a trade on PCH

Bought the 50,55 Aug strangle for 1.40.

Reasoning for trade:

1) 3 month Implied vol is currently 14% cheaper than 3 month realized vol.
2) 3 month Implied vol is also in the 3rd percentile.
3) Stock is heavily correlated with lumber. Lumber Term structure is showing high vol until August and then it drops off.
4) Lumber is also at an all time high (usually an inflection point).

Assuming I bought cheap vol compared to future vol. Where should I take profits? Should i hedge every 100 Deltas? Should I just wait till expiry? Does anyone have Ideas on how to optimally profit from buying cheaper than expected vol?

 

[JackRab]

My sheets say the last bid is 3.55, 1.65 for the call and 1.90 for the put...

I'm assuming you did a paper trade? Am I missing something? It's either a brilliant trade or you've messed it up with something else...

 

[Robert Morse]

I'm also seeing a mid-point of 3.55. I do like the way you looked at it though and earnings are in May.

 

[believezz]

Gamma scalping (periodically resetting to delta neutral) should lower the pnl variance but with hedging costs so over-doing it could be costly. Holding to maturity is the other end of the spectrum with theoretically the highest variance and also EV. There should be a sweet point somewhere in between. Maybe every couple of days depending on actual vol.

Or a better solution is keep trading options to maintain desired greeks on a continuous basis.
Options trading should be dynamic. Forget the expiry date / payout diagram because that's static, instead focus on the greeks today and T+1. But this requires continuous monitoring.

Jeffrey

 

[jordanwrong]

Yes it was a paper trade, I am practicing my delta hedging. The bid and ask was a lot wider in the morning and ToS filled me at 1.40. Showing a nice profit now LOL. But in general If I think the fair value of the contract is $4. should i delta hedge until i hit that $4 mark and then close the trade?. Also would managing at regular intervals of say 100 delta give me the same p&l of managing at 50 delta?

 

[jordanwrong]

Gamma scalping (periodically resetting to delta neutral) should lower the pnl variance but with hedging costs so over-doing it could be costly. Holding to maturity is the other end of the spectrum with theoretically the highest variance and also EV. There should be a sweet point somewhere in between. Maybe every couple of days depending on actual vol.

Or a better solution is keep trading options to maintain desired greeks on a continuous basis.
Options trading should be dynamic. Forget the expiry date / payout diagram because that's static, instead focus on the greeks today and T+1. But this requires continuous monitoring.

Jeffrey

When looking at the greeks I am long gamma long vega short theta. Considering my theory is vol will increase, I want to be long vega and gamma. So should i only be concerned with managing my deltas?

 

[destriero]

It is analogous to attempting to arb skew. The vol-discount is moot if there isn’t any discrete hedging. Think of vol as synthetic time.

 

[jordanwrong]

It is analogous to attempting to arb skew. The vol-discount is moot if there isn’t any discrete hedging. Think of vol as synthetic time.

Could you break this down a bit? What's an example of arbitaging skew? And when you say vol discount is debatable without hedging...are you saying if you don't hedge you dont have a way to see if you realized it or not?

 

[destriero]

Could you break this down a bit? What's an example of arbitaging skew? And when you say vol discount is debatable without hedging...are you saying if you don't hedge you dont have a way to see if you realized it or not?

Skew as an analogy. The risk-reversal May be trading 800bp to the downside; meaning that the OTM puts(ITM calls) are trading 8 vol over the equidistant calls(puts). How do you arbitrage that? You cannot; it’s PC parity.

Buying the 50/55 outside strangle at x requires one of two assumptions. That A, you’re going to treat it as a binary and hope to cover at some future date or B, that you’re going to hedge with (likely) underlying assuming that the fwd vol will exceed the vol you paid.

If passive, then you must go into it as a binary-event, and understand that a cheap straddle at 15 vol today becomes a 17 vol straddle in two weeks. The need for stat vol to trade at 17 (frictionless). Hence vol as synthetic time.

 

[mushinseeker]

hi destriero, so when you say "think of vol as synthetic time" do you mean think of implied vol or realized vol as synthetic time? Just to clarify, if you put on a straddle "x" for $2 and 1 week later it is still $2 for whatever reason, how does the above comment apply to this position X? Thanks.