Pairs trading with options

Quote from maninjapan:

WIth equities, I can just purchase an equal dollar amount of shares. If I was straight puts or calls I could trade equal amounts of delta. But in this case the trade is delta neutral (at least when I put it on) meaning I need to look somewhere else.... But in this case the trade is delta neutral (at least when I put it on) meaning I need to look somewhere else.... Has anyone had any experience with these strategies, used a position sizing technique that may be transferrable or know of any academic material that might cover something similar?
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Quote from maninjapan:

I was actually selling equal amounts of vega. Do you mean if IV of A is 20 and IV of B is 10, then sell 200 sets of B and sell 100 sets of A??
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I'm confused on two accounts. Are you buying or selling the options? And if you're putting the trade on as delta neutral then why are you looking elsewhere?

And even w/o knowing what you want to do, I'd suggest that you test your strategy on historical data. Let performance indicate viability.
 
Quote from Martinghoul:

I define a multiple leg option trade as "premium-neutral", if and only if the net premium (expressed as the actual $ settlement amt) paid or received is zero. I thought the term is unambiguous, but I guess I was wrong.
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I wanted to make sure we have the same definition of neutral. The statement about vol. (in the context of the question/comments by the poster) remains. Vol./dollars are "same" thing (pricing model makes allusion they are different).
 
Thanks guys, lesson learned. One cannot expect clear answers when the question itself is confusing. Let me try again......

I have an equities pair strategy (I see no reason why the same strategy wont work on futures however).
Lets say MSFT-SPY as an example.
I use a spread based on their IVs to create entry signals. When I deem the spread overpriced I will sell a strangle or straddle on the front symbol (MSFT) and by a straddle or strangle on the back (SPY).Wether to keep both positions delta neutral or jsut let them go is something I am still testing. I also only take positions of they are net theta positive or at least theta neutral.

My questions however, are in regards to position management.
My initial thought was to hold equal positions in vega, -1000 vega on MSFT, +1000 vega on SPY. However I wasn't sure if this was leaving me overly exposed in some other area.
My next idea was something similar to what was suggested, take a position that will offer similar exposure if they both finish in the money (at least I think its a similar idea).
In order to do this one must forecast actual volatility. (which I used to be able to do till I broke my crystal ball). So I currently use the Std dev of the 2 symbols because it seems to be as good as anything else. The ratio of MSFT's Std dev to SPY's Std Dev gives me my position size.
If the 2 symbol's volatility continues to move in this ratio for the life of the trade then I should win or lose based on my analysis. MSFT's actual volatility increasing compared to SPY's vol. is a risk that I take( this would leave me further in the money than I expected). The opposite makes my trade easier. Any significant change in the spread of the underlying or a break down in the correlation will make things a bit trickier.

Now apologies for the essay, and I have possibly oversimplified things but I hope this makes things a bit clearer. I have been doing backtesting but it is quite time consuming and have only completed limited trades. My tests to date however show that I am at least headed in the right direction. Does anyone have any opinions on this or some advice or suggestions? Any glaring holes in the understanding of the risks that I am taking?
 
Quote from tradingjournals:
I wanted to make sure we have the same definition of neutral. The statement about vol. (in the context of the question/comments by the poster) remains.
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Sure, that's fine, clarity is a wonderful thing...
Vol./dollars are "same" thing (pricing model makes allusion they are different).
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No, they most emphatically ain't the same, but I don't think I am capable of further discussion of this. And I also have no idea what you mean by "pricing model makes allusion".

Anyways, let's not hijack m-in-j's thread any more. Hopefully, an equity vol guru can come along to help him out with some useful pointers.
 
Mart. I do plan to test this on futures some time soon. Just that the equities data is much easier and cheaper to come by.
What advice would you offer in regards to position sizing, if I was using a similar strategy on ZS-ZW or ES-NQ or RB-CL or any other futures spread ? My initial thought would be a similar calculation as to what I have posted with consideration for any difference in point values.
 
Quote from maninjapan:
Mart. I do plan to test this on futures some time soon. Just that the equities data is much easier and cheaper to come by.
What advice would you offer in regards to position sizing, if I was using a similar strategy on ZS-ZW or ES-NQ or RB-CL or any other futures spread ? My initial thought would be a similar calculation as to what I have posted with consideration for any difference in point values.
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m-in-j, I can wax poetic on these subjects, where bond/STIR futures are concerned, as I trade these things. Let me know if you wanna read the poem :).

However, I prefer not to comment on index or energy futs, as I have no experience with those mkts.
 
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