Past floor traders

"Vol down -> ATM trades lower while OTM doesn't move (you don't lose)"
Are you sure otm doesn't move I have always seen it drop when vol drops? What is their optimal dte for being long the wings or do they just keep them as even as posible in each expiry?
 
getthatintoya said:
"Vol down -> ATM trades lower while OTM doesn't move (you don't lose)"
Are you sure otm doesn't move I have always seen it drop when vol drops? What is their optimal dte for being long the wings or do they just keep them as even as posible in each expiry?
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So here is what you do:

Go to https://optioncreator.com/new

Create the following position:
upload_2021-5-26_13-36-13.png


Then toy around with adjusting the implied volatility in the chart below.

I just eyeballed the strikes so don't hold me hostage on the 25 delta wings, but you'll get the idea.

In addition:
https://www.pierinoursone.com/single-post/2015/11/27/the-vega-riddle
 
From what I've seen in SN over the past few years, I think edge loss is highest on otm wings going into expiry. Especially with recent rise in retail buying these. There are times when it feels like the MMs start getting full on short wings and begin over-skewing them to protect themselves.

Also because of the fact that they are attractive to MM as well, as you mentioned, in order to conduct operations local to spot without picking up a ton of risk, as an MM I would be willing to buy these closer to neutral or even at a marginal edge loss financed by general PnL from collecting the spread.

So there is some wisdom in the initial position mentioned by the OP. But only under certain vol regimes. Ratio'd calendars in backwardation are not that easy to make money off of, at least for me. If you are overbuying long gamma somewhere to get flat, that usually ends up sucking away a lot of PnL when the trade finally comes off. Especially if the back leg vol was also lifted off the floor by whatever shock caused the backwardation and it rapidly deflates. Hard to keep up with that even when your short gamma is performing very well. And with little time to expiry it gets harder and harder to keep your exposure local unless you're trading stuff with really tight spreads.

Trying to balance risk : reward as a retail trader is tricky. Floor traders could get in at edge so it's not as big of a deal to overspend on the risk-reducer leg for them. I agree largely with a lot of what Muppet said. The term structure and skew dynamics make a lot of difference on what the outcome of a trade like this will be. There's no silver bullet and technology is good enough to where there's no free stream of money sitting around in the vol complex. You need to do a decent bit of risk taking and/or speculation if you want to generate PnL here. And even then it's sometimes tough to keep up with your vanilla risk on strategies like buy & hold stocks or selling index vol, in normal markets.
 
Magic said:
From what I've seen in SN over the past few years, I think edge loss is highest on otm wings going into expiry. Especially with recent rise in retail buying these. There are times when it feels like the MMs start getting full on short wings and begin over-skewing them to protect themselves.

Also because of the fact that they are attractive to MM as well, as you mentioned, in order to conduct operations local to spot without picking up a ton of risk, as an MM I would be willing to buy these closer to neutral or even at a marginal edge loss financed by general PnL from collecting the spread.

So there is some wisdom in the initial position mentioned by the OP. But only under certain vol regimes. Ratio'd calendars in backwardation are not that easy to make money off of, at least for me. If you are overbuying long gamma somewhere to get flat, that usually ends up sucking away a lot of PnL when the trade finally comes off. Especially if the back leg vol was also lifted off the floor by whatever shock caused the backwardation and it rapidly deflates. Hard to keep up with that even when your short gamma is performing very well. And with little time to expiry it gets harder and harder to keep your exposure local unless you're trading stuff with really tight spreads.

Trying to balance risk : reward as a retail trader is tricky. Floor traders could get in at edge so it's not as big of a deal to overspend on the risk-reducer leg for them. I agree largely with a lot of what Muppet said. The term structure and skew dynamics make a lot of difference on what the outcome of a trade like this will be. There's no silver bullet and technology is good enough to where there's no free stream of money sitting around in the vol complex. You need to do a decent bit of risk taking and/or speculation if you want to generate PnL here. And even then it's sometimes tough to keep up with your vanilla risk on strategies like buy & hold stocks or selling index vol, in normal markets.
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Agree 100%
The difference between retail and pro is the fact that retail sees positions as strategies and for pros it's inventory.

There is a difference between trading against a stable inventory to make money on the bid/offer and slapping on a position to profit from decay.

Edge loss on the wings for retail is edge gain for the MM, of course.

As far as ratio'd calendars are concerned, you want to put on a time fly aka short front, long mid, short long term and for that you need a dislocation in the term structure.

Again, the difference between retail and MM is the fact that MMs are actively skewing their quotes to exploit dislocations whereas retail doesn't even have a look at vol curves and just slap it on because the hockey stick graph looks nice.
 
MrMuppet said:
Agree 100%
The difference between retail and pro is the fact that retail sees positions as strategies and for pros it's inventory.
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Took me a while to realize that it was an unstated but obvious premise in quite a bit of the options literature I've read, but yeah. The problem is that it takes a pretty good sized account to, say, short 100 straddles, hedge that position, and then trade against it - so a good bit of what these guys are writing about isn't really usable by a typical retail trader. For them, it's more like "read Hull... then figure it out from there. Good luck, and BTW there are sharks in these waters." :)
 
Double diagonal and it's easy to stress. Price the Jan22 straddle at 1M when your short goes off. How much decay (at neutrality)? You're going to find that you're going to need to get close to your wing to compensate for the decay on the back vol, unless it's explicitly chosen to be long the vol-line. Stress the neutral Jan22 straddle 30 days forward and see how much prem you'll need and go as far OTM (wings) to support the decay at neutrality (in a month). You're not going to like the stress inside 1SD.
 
BlueWaterSailor said:
Took me a while to realize that it was an unstated but obvious premise in quite a bit of the options literature I've read, but yeah. The problem is that it takes a pretty good sized account to, say, short 100 straddles, hedge that position, and then trade against it - so a good bit of what these guys are writing about isn't really usable by a typical retail trader. For them, it's more like "read Hull... then figure it out from there. Good luck, and BTW there are sharks in these waters." :)
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That's why I'm stating it here.

Thing is that a position doesn't magically evolve into a strategy just because you look at it from another angle. If the account is too small to trade the correct ratios, either trade a cheaper underlying or just don't trade volatility at all.
 
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