Shorting the Skew...

J

jansen_ja

I have been looking for some way to short the skew found in many optionseries, trying to earn the skew, or at least some of it.
I came up with a position (didnt trade it though) in the dutch AEX index. It is made delta neutral with shorting the future of the AEX index. The same strategy can of course be done on many more indexes.

Index future for januari is trading at 335.
short -4 AEX-mini futures. (80 deltas, 20E per point per future)
long 1 jan 340 put at 8.00 euros
long 2 jan 320 put at 1.40 euros
long 1 jan 360 call at 0.20 euros
short 15 jul 260 puts at 5 euros.

The profit/loss graph looks something like this (trying to make some best estimate on increasing volatility when declining etc...)

above 335 : profit of 700 euros or more when above 360
belove 335:profit of 700 euros increasing to 2000 euros at 280, then declining to unlimited loss!!
So because of the skew you are kind of gamma long and theta long. In return for this you get downward vega risk.
The profit of 2000 euros is calculated with an increase in IV from 22 to 30 for the atm's when declining from 335 to 275.

Apart from the ridiculous margins you need for this kind of position,at least in retail accounts, can somebody make some wise comments, why this is a good trade, or why this doesnt make any sense at all and should be forgotten as soon as possible....

Waiting for hearing some wise reactions...

JJ
 
Quote from jansen_ja:

I have been looking for some way to short the skew found in many optionseries, trying to earn the skew, or at least some of it.
I came up with a position (didnt trade it though) in the dutch AEX index. It is made delta neutral with shorting the future of the AEX index. The same strategy can of course be done on many more indexes.

Index future for januari is trading at 335.
short -4 AEX-mini futures. (80 deltas, 20E per point per future)
long 1 jan 340 put at 8.00 euros
long 2 jan 320 put at 1.40 euros
long 1 jan 360 call at 0.20 euros
short 15 jul 260 puts at 5 euros.

The profit/loss graph looks something like this (trying to make some best estimate on increasing volatility when declining etc...)

above 335 : profit of 700 euros or more when above 360
belove 335:profit of 700 euros increasing to 2000 euros at 280, then declining to unlimited loss!!
So because of the skew you are kind of gamma long and theta long. In return for this you get downward vega risk.
The profit of 2000 euros is calculated with an increase in IV from 22 to 30 for the atm's when declining from 335 to 275.

Apart from the ridiculous margins you need for this kind of position,at least in retail accounts, can somebody make some wise comments, why this is a good trade, or why this doesn't make any sense at all and should be forgotten as soon as possible....

Waiting for hearing some wise reactions...

JJ
More...

I wouldn't consider trading it. Your position *somewhat* resembles a short time spread. Yes, you're skew-advantaged, but carrying a lot of short vega exposure. Any skew edge received is offset by the front month short theta.

The futures risk is substantial, coupled with the long puts in the front month -- as we rally, the July put skew will actually increase, denying your edge in the July series, you'll gain a bit on the short July premium, simply fron delta, but get absolutely killed in the front month puts and short futures.

You're selling volty in the back month at near historic lows on volatility. I wouldn't consider selling net vega in any deferred contracts -- the position isn't half bad if you forego the short futures, but I don't relish selling the July premium.

My advice would be to attempt to work front month strategies -- short Jan or Feb puts// short futures, K.I.S.S.

arb.
 
Thanx for your reply...
The futures are by the way mini futures... so the 4 futures together are having just 80 deltas... maybe still too much... maybe 3 futures would be better...having -60 deltas from the futures.

Still, i am gonna see how this kind of stuff is gonna work out the next few months....
I just think skews are sometimes pretty big... and i think too big... and so there must be a good way to earn money selling that premium...
yes, maybe it is not the best time to do this kind of trades... because of low IV levels, I know
Still i believe in the long run selling skew must earn money.
Partly I think skew is something like some kind of fashion...
The theory of substantial increasing volatility with declining market i know of, but is this enough truth to offset the skew found in index options...???
Then more i could understand this kind of skews for stock options, where a stock can trend incredibly to 10fold value or 1/10 value. With index options the panic is only ones in a couple of years, and then even you will have time to close the position at an acceptable loss..... , working with stoploss...
Though anyway I am not aware of the mathematics behind all the models calculating skew.

Or are there better ways to sell the skew?
Or is there no way to sell the skew of indexes, without being a 100% gambler.........
 
Quote from jansen_ja:



to 2000 euros at 280, then declining to unlimited loss!!
So because of the skew you are kind of gamma long and theta long. In return for this you get downward vega risk.
The profit of 2000 euros is calculated with an increase in IV from 22 to 30 for the atm's when declining from 335 to 275.

JJ
More...

Disregard my short time spread comment, was attempting to distill this position with one word, my bad.

You're not gamma long, no sir. You're net short 12 deferred puts, the skew decreases as you go into the back months, further diminishing what skew you thought was available. My point is that skew doesn't invert gamma.


arb.
 
Quote from jansen_ja:


Still i believe in the long run selling skew must earn money.
Partly I think skew is something like some kind of fashion...
The theory of substantial increasing volatility with declining market i know of, but is this enough truth to offset the skew found in index options...???
More...

All of my trading involves selling the skew. And yes, the skew can offset a large portion, if not all, of the increase in avg. volty across the series during a declining market.:D

arb.
 
Could you give me an example of the kind of skew selling position you would go into?
I am curious, I would like to get some more insights here...

I try to do it with individual stocks, when i dont agree with differences in volatility levels/extreme skews... but no rules here... every situation is different...just when my evaluation is completely different then the market i will trade.
Though i am still on a retail account. Within one week i will have my haircut/leveraged account for the more serious work...
 
Quote from riskarb:

All of my trading involves selling the skew. And yes, the skew can offset a large portion, if not all, of the increase in avg. volty across the series during a declining market.:D

arb.
More...
riskarb,

Who do you use as a broker?

nitro
 
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