Lets talk variance

[.sigma]

Exactly. If there is a large outstanding variance swap position in the market, dealer hedging could impact the behavior of SPX around the close. The interesting bit for a retail trader is the short-term trade opportunities that creates around the close - the actual change to daily volatility will be relatively small.

sle, this reminds me of open interest for options on single-names, kind of. Pin risk of some sort.

I've been utilizing wing-spreads a lot lately (ATMF put flies usually) on single-names and sometimes on index or ETF's.

But when I'm in the option chain, I do glance at the OI for different strikes, to gauge where other contracts are being traded at.

I also use volume by price, which IMO is an amazing "indicator", one of the few indicators I actually use when trading, it gives a good gauge on what prices have the most activity.

When you say "if theres a large outstanding var-swap position in the market" do you mean at an a specific strike level? Or multiple? I'm not even too sure if variance-swaps have strikes? I'm assuming they do though.

Could a retailer structure butterflies around this short-term trade opportunity around the close you speak of on the SPX?

Cheers

 

[Straitjacket]

I am not Sle and Sle is not me. Very important point, should SEC ask


Assuming the dealer has a perfect hedge on (i.e. the strip vs the variance swap), he does not have any gamma intraday, he only going to have to hedge the daily reset. I.e. he does not actually have any gamma because his convexity is perfectly matched. Granted, this is not always true (e.g. large gaps are going to disconnect your hedge from the swap) but it's true enough that most dealers are not gonna bother unless the move is huge.


That's the tricky question. You can use the clearing house history to see the flows and attribute them, pretty sure that data is publicly available from the clearing house. Alternatively, you can look at the strength of the previous impacts and try to back out the size of the outstanding gamma.


Well, the dealer only cares about the variance swap payoff that's calculated from the close to close returns. So from his perspective, even if he's marking the close, he's golden (if anything, he likes that impact if he's not fully hedged). But from the markets perspective, the market makers will pull back when they see the target-close imbalance and will buy it back into the settlement (thus making money to the retail guy that decided to play this game )

Thanks for this feedback! I found the clearing data, very interesting stuff. I have to try and learn some more R to wade through it.

Can I throw some follow up questions at you? Really excited to learn more.

What specifically makes this a retail appropriate strategy? Is it because the volume on the futures drops after the cash close and we're trying to close the trade after cash close (less liquid market)? If there were an exploitable edge, would this be an example of a small structure edge that would permit us to eat some of the dealers' or MM's lunch?

There seems to be some triggered, programmatic trading at specific time intervals before the cash close. Should that be considered in the analysis or eliminated? I'm not sure how to isolate.

Is there any relevance to the divergence between the cash and the futures @ EOD? I note some weird divergences, but not clear on what they mean. When that occurs, I notice soem sizeable continuation and reversions in those cases.

Finally, there seems to be occasions where this is ripe to happen (big difference between afternoon trading and previous close), but completely fizzles out. From my prelim look at the clearing data, the SWAP volume doesn't look like it changes hugely between one day to the next.

What skills does this require for a retailer to get a good handle on what's going on?

 

[Amahrix]

I'm surprised ET has a "Fixed Income" forum yet no Volatility forum.

Anyways lets get a discussion going on variance.

I am a complete neophyte when it comes to variance, I just know the basic sq. of vol stuff, but I'm trying to understand this stuff better.

I've read @sle and I know TBS knows quite a bit about variance as well and others here.

Has understanding what variance is, the functionality of variance swaps, how to price them etc.. helped you in understanding the concept of vol better? I'm assuming yes. This is why I'm learning more about var as it compares to vol.

I'm curious what you variance guys think of the BSM, because BSM uses vol as a measure of financial deviation, not var... yet I'm reading Bennett and seeing that the industry created the modern $VIX formula to move away from ATM vol (VXO), towards variance-based calculation.

Do vol forecasting or value models like GARCH use variance as the st.dev?

The best thing you can do you for yourself is to read and follow Nassim Taleb

 

[.sigma]

The best thing you can do you for yourself is to read and follow Nassim Taleb

I have been for many many years my friend. Thanks though.

 

[Amahrix]

I have been for many many years my friend. Thanks though.

Respectfully, if you understood it. You wouldn’t be asking such questions. Read the technical work that relates to statistics by Nassim.

 

[ironchef]

The best thing you can do you for yourself is to read and follow Nassim Taleb

Read the technical work that relates to statistics by Nassim.

I can kind of understand The Black Swan, Fool By Randomness but the mathematics? Too mathematical for me to comprehend.

Any suggestion what I can do other than go back to school?

 

[.sigma]

Respectfully, if you understood it. You wouldn’t be asking such questions. Read the technical work that relates to statistics by Nassim.

well obviously lol

but I’ve been reading the works of nassim for years bro... doesn’t mean I understand the shit lol

 

[.sigma]

I can kind of understand The Black Swan, Fool By Randomness but the mathematics? Too mathematical for me to comprehend.

Any suggestion what I can do other than go back to school?

hes talking more dynamic hedging math.. which imo I don’t think you need to know.
The basic algebra stuff yeah but idk about PDE’s and such.

look up Nassims paper “Silent Risk” and look at those damn equations smh lol

 

[Same Lazy Element]

The best thing you can do you for yourself is to read and follow Nassim Taleb

What does Taleb have to do with understanding variance swaps?

PS. pretty sure he left the market before var swaps were a thing, too

 

[.sigma]

What does Taleb have to do with understanding variance swaps?

PS. pretty sure he left the market before var swaps were a thing, too

i thought the same.

he thinks I need to understand Taleb’s concepts to understand variance.

also I want to make this clear. I’m not really trying to understand the math behind these things. Doesn’t mean I won’t, I’m just saying it’s not my motivation.

I just want a better overall understanding of what variance is, and variance swaps, and how to understand volatility and it’s relations.

if variance swaps are a way to play pure vol, that peaks my interest. Doesn’t mean I’ll trade the damn swaps, but having an understanding of them could benefit my own trading method in the future.

And variance swaps aren’t it, I look at all advanced derivative theory with a grain of salt.

I’m pretty sure I’ll never need to know what Volga is, but knowing that Vega convexity exists and how to apply it to understand the mechanics of optionality wont hurt ya.