atticus, would you mind expanding on this a bit? When you say gamma trade the spot. Are you refering to gamma scalping each of the pairs to keep them neutral through the trade?
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Pairs trading with options
- Thread starter maninjapan
- Start date
Quote from maninjapan:
atticus, would you mind expanding on this a bit? When you say gamma trade the spot. Are you refering to gamma scalping each of the pairs to keep them neutral through the trade?
Adjust -correlation through a delta-trade in the underlying pair. For example, in the NDX/SPX trade you could short the upside calls in NDX, buy the SPX calls (=notional), and adjust in the NQ/ES spread as you see divergence. Of course, in the NDX/SPX trade you will need the spot pairs-trade from inception. I realize this keeps you trading a combo of spot and options.
I've done this quite a bit in earnings-situations on industrial companies where the reporting vol is unsustainable and the pair tracks well. Or short JPM calls, long GS into this reporting day. JPM vols imploded yet GS retain their vol until they report.
I think it's important, as Marti suggested, that you keep premium-neutral (long gamma/short vol-box) in these situations which reduces the need for a position in the underlying pairs trade.
Thanks Atticus. Any particular reason why you use just one side in the options (calls) instead of a delta neutral straddle or strangle? This is the way Ive been testing them, using the underlying to keep each strangle delta neutral. Guess its achieving pretty much the same thing though....
Quote from maninjapan:
Thanks Atticus. Any particular reason why you use just one side in the options (calls) instead of a delta neutral straddle or strangle? This is the way Ive been testing them, using the underlying to keep each strangle delta neutral. Guess its achieving pretty much the same thing though....
Less risk of pinning/inversion. Being pinned on long gamma and deep on short gamma. Also, you gain convexity/speed (dgamma) on your long gamma leg/position.
Well, to make a long story short, it will always be one of two cases:Quote from maninjapan:
Im all ears!! (well I guess that should be eyes, but anyway.....)
A) weights that make the end position flat DV01, assuming both legs ITM at expiry;
B) weights that make net premium 0, in which case I'd probably be delta-hedging.
I don't really do B trades any more as it's too expensive, in terms of my time, as well as transaction costs. I just wait patiently for the opportunity to use options to pick up juice in fwd space vs spot on trades that I like on their own merits (in these cases, I'd also do zero net premium by picking the strikes).
could someone give me an example of a premium neutral trade?
mart. thanks for the reply. so by net premium zero, you mean across the 2 different products? so if I was long 1000 theta in ZB, you would have a position that made you short 1000 theta in ZN (using a ZB ZN trade as a an example)
Corelio, right. Thats why I started looking for something else. By just focusing on Vega, I was ignoting all the other risks.
Quote from maninjapan:
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.
However I wasn't sure if this was leaving me overly exposed in some other area.
The answer is a clear Yes. Think of theta and gamma as opposite forces. Large theta implies large gamma short. Large theta short implies large gamma long.
If you are theta positive then you're more than likely exposed to gamma risk.
I would also emphasize the fact that the right terminology for your strategy is a pair volatility trade and not just a simple pair trade. You're basically trading the mean reversion in IVs via volatility spreads.