Picture a put backspread...

[ferrycorsten]

...positive gamma, positive vega...wants increasing IV...but when the underlying shoots to the upside around or beyond the short puts, the vega becomes negative and the backspread benefits from a decline in IV. Does it really benefit though? Because even if IV rises, realized vol will win out and the position will still be profitable.

Same with a call backspread...the upside wants increasing IV and the downside, decreasing...but does IV even matter if the underlying blows past the short calls? Because you will still have a nice profit anyway.

What do you guys think of a strategy that identifies stocks with big historical vols, and throwing backspreads on them? The question is, do you want stuff with high or low IVs? Because the way I see it, IV will only benefit you in one direction.

 

[gulatin2]

Stocks which displayed high historical vol doesn't necessarily mean they will exhibit the same again. There can be multiple reasons for it. Buying premium can be pretty tricky. You can forecast increased volatility in future using the models but if market is pricing in low IV there has to be reason for it. With back spreads you are essentially buying gamma and positive to skew if long gamma. Everything needs to be put into a perspective. If underlying doesn't move in a week after you put the trade on , probably it will be better to get out as theta will kill the trade and will be difficult to recover.

 

[newwurldmn]

Show a structure that has this profile.

 

[nazzdack]

Quote from ferrycorsten:
----positive gamma
----positive vega....
----increasing IV....
----but....
----throwing backspreads....

Nobody trades backspreads. There's always too much fear that the underlying cannot "get beyond" the strike price of the short-option.

 

[atticus]

Ferry, your assumptions, especially w.r.t. stat-vol are inconsistent.

 

[cdcaveman]

Quote from nazzdack:

Nobody trades backspreads. There's always too much fear that the underlying cannot "get beyond" the strike price of the short-option.

thats not true at all... i know of people that buy deep otm in higher ratio then the puts they sold closer to the money.. ... theres alot of ways to look at a backspread.. your basically expression that the value of the deep otm is less expensive relative to the Atm strikes.. increasing skew or a outright huge move in the underlying will make money in this.. it brings convexity back in your favor out in the wings.. i've never been sucessful with it.. they are hard to trade as a structure themselves.. but there definitely are people covering their put sales with farther otm options..

 

[nazzdack]

Quote from cdcaveman:
----I know of people....
----buy deep otm in higher ratio then the puts they sold closer to the money....
----there's a lot of ways to look at a backspread....
----I've never been sucessful with it....
----they are hard to trade as a structure themselves....
----there definitely are people....

If indeed you know "people" with the sophistication/fortitude to trade put-backspreads, is it possible that they're hedging that position with a ratio-put-spread, (i.e. an inverse put-backspread), somewhere else?

 

[cdcaveman]

No..... Its more like just covering naked puts with a higher ratio of further otm put purchases.. You get less of a credit.... But if the underlying completely tanks you aren't holding the bag.... If it goes down moderately you can dump the long premium for profit and take the naked risk... That or you can just reduce the amount of longs you have on... I haven't traded it very extensively...