Long-vega "Airbag" trade

N

nakedoption

Dear community,

This is my first post here, I'm not an native speaker so please apologize any English mistakes...

At the moment I'm trying to implement some long vega strategies with respect of the very low VIX levels. Generally I'm trading long theta strategies like short puts/calls, straddles and strangles (stocks, equity futures and also crude oil) and I want to prepare my account for an increase in volatility.

I have seen a youtube clip from an (self-proclaimed ;-)) options expert who demonstrated his "airbag" strategy using deep otm SPX puts (original clip is in German language). He is trading ratio spreads (3:2 ratio) in different expirations, the strikes were >400 points below current SPX and the difference between short and long legs were merely 25 points. When an market crash occurs, the spreads will inflate considerably due to their vega sensitivity.

Roger, no magic so far. In the commercial the author proclaimed that he is able to set up the ratio spreads most of the time for a small credit, therefore he is setting up the spreads on a rolling basis. Hopefully I'm not completely stupid as I suggest that he must open the short leg first and the long leg afterwards (no free lunch out there). He said that his strategy isn't risky even during that implementation period as he is using a "trick" to do that. He got my attention and I asked him how to do it but the reply was buy my coaching session for some 900€ blah blah. Obviously that works in Germany as option trading isn't very common here due to the fact that most "investors" waste their money by trading warrants or CFDs.

I'd like to try this strategy by e.g.
selling ES 2100 Nov puts (ratio 2x)
and buying ES 2075 Nov puts (ratio 3x) afterwards with a small credit if possible

How can I protect the downside risk before the long leg is in-place? My idea was to buy an cheap weekly put that is much closer atm, but how will this hedge volatility?
Are here some option geeks who are able to help out?

Thanks
 
ratio backspreads... its like taking a butterfly and buying more wings with profits... or putting on ratio backspreads along with short straddles... i don't think you can put them on for a credit unless you really really spread the strikes out which is a risk in itself... legging in is a risk in itself.. like you said there is no free lunch.. you either pay for cheaper deep otm protection with a ratio backspread and make it up selling atm meat or leg into one of these deep otm and take a the pain one day when you get caught with your pants down... look up the pnl of a ratio backspread... its pretty convex.. you get alot of punch in a crash for holding these
 
Traders have done that forever- legging into spreads by exposing the position to 1 greek risk to get better prices. eg. Theta risk - selling a straddle, hoping for a quiet 3 days, then buying the wings to bring the entire graph higher. Gamma risk- shorting a fly, hoping for a big move in 3 days, then selling out a vertical , again to bring the risk graph higher. Delta risk- buying a vertical , waiting for a directional move, buttoning up the risk by turning it into a fly. The secret sauce is in the prediction of the probability distribution of the underlying. Your idea of the layered implementation of the 2:3 has merit if certain things break your way- specially a HUGE downmove after stage 2. BUT you can get hurt massively if 2 things happen 1) crash before your wings purchase and _____________ can u guess? :-) BTw, your weekly put purchases is ok due to low IV but be ready to experience slow PnL bleed unless of course the crash happens the day after your put purchase.
 
nakedoption said:
he is using a "trick" to do that
More...
If this doesn't raise any red flags I have a bridge to sell to you :-)
Seriously if you buy deep OTM backspreads you are going to be losing most of the time until that time when the crash happens. This is not as outlandish as it sounds as I believe Taleb uses something similar and his is a mind I definitely respect but as a retail trader I would find it very hard to wait for something like that to happen.
I find it hard to believe, considering Vol Skew in OTM puts, that any trader can put on a 3x2 put backspread ratio for a credit unless he is legging into the trade (or maybe using his magic trick) or using a very large spread between the short and long legs (which kind of defeats the purpose of the backspread). I would like to know more about this if anyone has implemented this strategy or something similar with any degree of success
 
TD, good catch on the put skew in US equities. Totally missed that one which would make the pricing even worse for the put b/spread.
 
Thank you guys for your feedback, much appreciated. You're right, I'm pretty sure that he is legging into the spreads. The put skew is unavoidable, the spread was always just 25 points. Maybe that legging-into approach is okay when there are already existing ratio backspreads in different expirations which could adsorb a crash event, but it seems to be dangerous to initiate the short leg (given the low implied vola) while hoping that nothing happens for the next trading sessions... One could start this strategy by protecting the portfolio with a long put which is closer atm.

Nevertheless I'm asking myself if this "black swan" strategy is appropriate for retail traders after all. If I'd ask IB they would definitely like it as it generates a lot of commission during the year ;-) Are you using such hedging strategies e.g. with VIX risk reversals or such SPX otm puts?
 
Its impossible to be prepared at all times for a Black Swan, be fully invested in the market and not lose substantially (either in real or in profits foregone) due to the high cost of 'insurance'. Any hedging choice is therefore a trade-off that should fit within your general investment strategy. I am not going to go into the obvious things to do like not over-leveraging yourself, keeping an eye on your delta and yada yada. Just from the premise of low volatility my current 'hedging approach' is two fold:

  • make sure I have some trades playing on volatility such as selling index Iron Condors on a spike and trading double calendars towards earnings of stocks
  • make sure to have some straddles open before earnings (hedging the investment risk due to natural vega inflation before earnings) so that there are always a number of positions that would benefit from a crash but which I can close for small losses at worst if the market doesn't move at all;
  • sell puts on the ^VIX when its around 10 and I am really worried something might happen. To reduce margin requirements (in my case) you can buy 9 strike ^VIX puts as that is probably the theoretical minimum that index can go to.
Note that the last point is a last resort and I haven't used it this year yet - I might next week. Its impossible to do this months ahead due to the peculiarity of pricing on VIX options. You can probably reasonably buy a month worth of protection going further doesn't give you enough. Why selling puts rather than buying calls? Simple - in the event of a crash calls go very illiquid and you often cant get out of your position as the other side knows the volatility will fall from the most brutal spike and the options are European style. Puts also suffer from this but its less pronounced when you were on the sell side. Needless to say if nothing happens theta is not your friend.
 
just occured to me that we may be assuming that he shorts 2 puts then puts on the 3 wings - maybe that guy puts on a -1:+3, waits for a small downspike, then sells the extra put turning into a -2:+3- that I would do!
 
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