Questions for Mark about Insurance

D

drcha

Mark,

Truly enjoying your new book. I have two questions about insurance and neutral trading. If others wish to chime in I would welcome comments from anyone.

1. In this atmosphere, I have been trading (wide) butterflies. I have much more experience with them than with condors, so I feel more comfortable with them. I do sometimes trade them with insurance, either at the longs or inside the longs. In your opinion, do flies lend themselves to insurance strategies less readily than condors, or what do you think are the pros and cons of each?

2. Recently, I have also been paper trading VIX call options. I have no experience at all trading them with real money so at the moment I am trying to observe how they actually behave. As I was combing through my paper trades this morning, and also unhappily bailing out of one of my NDX Feb flies, I was thinking it would have been a good time to have a real VIX call :) Do you have any thoughts about using these in conjunction with puts/calls on the underlying as insurance?

Thanks
Mary
 
Quote from drcha:



2. Recently, I have also been paper trading VIX call options. I have no experience at all trading them with real money so at the moment I am trying to observe how they actually behave. As I was combing through my paper trades this morning, and also unhappily bailing out of one of my NDX Feb flies, I was thinking it would have been a good time to have a real VIX call :) Do you have any thoughts about using these in conjunction with puts/calls on the underlying as insurance?

Thanks
Mary
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Careful Mary - options on VIX are very poorly understood by most.

For example, answer this question: Today the VIX closed at 51. If you had bought an April 50 put on the close, would that put have been in the money or out of the money?

If you answered "OTM," then BZZZZ - better keep your money in a safe place for now. That's because the underlying for the April VIX is NOT the VIX index. It is the April VIX futures contract, which closed at 43.37.

Strangely enough, there is absolutely nothing that ties the VIX futures to the VIX index, except at expiration. Last October the spread between the VIX index and the front-month VIX futures was over 30 points at one point - and more than that between the VIX and the back month futures. If you owned a 70 call when the VIX hit nearly 90, that call never went in the money, believe it or not. Lotsa people got screwed on that one.

There are lots of quirks and strangenesses to the VIX options and futures. Please be sure you understand them thoroughly before putting real money in them.
 
Quote from drcha:

Mark,

Truly enjoying your new book.
Thanks Mary

I have two questions about insurance and neutral trading. If others wish to chime in I would welcome comments from anyone.

1. In this atmosphere, I have been trading (wide) butterflies. I have much more experience with them than with condors, so I feel more comfortable with them. I do sometimes trade them with insurance, either at the longs or inside the longs. In your opinion, do flies lend themselves to insurance strategies less readily than condors, or what do you think are the pros and cons of each?

If flies are comfortable, stay with them. They are very similar to condors. That's why I don't see any significant difference when it comes to insurance strategies.

I try to keep things simple when trading. To me, the less risk, the less you need insurance. Wide flies are not cheap, unless very FOTM. Thus, the potential loss is significant and some type of insurance is a good idea.

If I collected 7 points for a 10-point iron condor, I would not bother with insurance because the potential loss is not large.

If I were to collect only $1 (I never settle for that premium), the potential loss is large and I go with insurance.

If I trade some iron condors when my normal size is 5 or 10 x that quantity, I don't take out insurance because I've already cut the risk by size reduction.

My point is that every trade does not have to be insured and it should depend on the potential profit or loss. If you consider yourself to be a good market prognosticator (with a proven track record), then your estimate on the safety of your position can be considered.

As an alternative to buying extra options, you can gain insurance by buying calendar spreads at a strike you want to protect. Of course, that method doesn't work all that well if the protected strike is approached quickly. In that event you would close your calendar (before that position adds to your losses from the fly), take your small profit and seek other protection.


2. Recently, I have also been paper trading VIX call options. I have no experience at all trading them with real money so at the moment I am trying to observe how they actually behave. As I was combing through my paper trades this morning, and also unhappily bailing out of one of my NDX Feb flies, I was thinking it would have been a good time to have a real VIX call :) Do you have any thoughts about using these in conjunction with puts/calls on the underlying as insurance?

Thanks
Mary

I have never traded these - primarily because they are European style (no early exercise) and the underlying is a futures contract. But, I'm with dmo.

But, if you are exposed to a good-sized loss if IV soars, it's okay to buy OTM VIX calls. Just be certain you understand that it's a good hedge when the options you own have an underlying that expires on a date that is near the date your other options expire.

You can buy puts to hedge risk of a huge IV decrease.

I'm not in position to suggest anything else, having avoided VIX options to date.

Mark
http://blog.mdwoptions.com/options_for_rookies/
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I think that puts and calls for insurance should be implemented by those who are more risk averse and are looking to shift the risk/reward ratio in their option strategies. It's not for everyone or for every situation.
 
Quote from spindr0:

I think that puts and calls for insurance should be implemented by those who are more risk averse and are looking to shift the risk/reward ratio in their option strategies. It's not for everyone or for every situation.
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I agree, if your positions carry the level of risk, that you feel you need to hedge then why put them on in that size in the first place!?
 
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