Skew Play

S

Swole15

I have been researching ways to profit from index skew changes and the research paper below has some good information.

http://www.mat.ucm.es/~ivorra/papers/TFMAG.pdf

The paper points to the fact that index skew gets steeper as expiration approaches. I am trying to think of a way to make consistent profits from this phenomenon and this is what I am thinking:

+3 SPY Nov 15 Puts at 185
-2 SPY Nov 15 Puts at 190
- 3 shares of SPY

Greeks at origination:

Delta: .16
Gamma: -.41
Theta: -.46
Vega: -.36
Rho: .58

Skew at origination:

-.022 / .025 = -.88

I would keep this close to delta neutral until a profit target is met. Has anyone used something like this or sees a problem with the strategy? Thanks in advance, I'm fairly new to option trading so any input is definitely welcome.
 
Theta and gamma increase as well. There is no method by which to isolate skew; or there wouldn't be any vol-smile. You're attempting to isolate drift (to skew) while not making mention of the stress is first-order greeks as we move and decay.

I understand ratio-ing the thing, theoretically, for drift to skew. Really, you're looking at terminal vol-edge and it's not enough to overcome to deltas in the position and the modality to (delta). You're in a wide otm backspread. The drift in skew wouldn't cover one contract in comms.

What's going to happen to the thing if we drop 5 SPY? OTM strikes will become local; do they rise or drop? Who knows. Sticky-delta > a rise in strips? Maybe, but in notional-terms? They're deep otm in a front-month so your vega will go ape as you approach your short strike, perhaps 10x impact from the curvature (smile). A pure backspread at the short-strike. The only thing you won't be considering is your slope. Color and speed are a fraction of a buck.
 
There's nothing wrong with coming up with theoretical notions.

But you should translate whatever edge you perceive into dollars and cents. You didn't include the option prices - that's reality.

Looking at the prices this morning I see that you could have received about a .20 credit for the backspread.

During my tenure as an option strategist, I perceived edges here and there, but I realized that I was either unable or unwilling to trade the size necessary to take advantage of a tiny edge.

And that's what you're proposing - a tiny edge, doomed to be overwhelmed by costs.

Shorting 3 shares for the sake of neutrality is too inefficient. Size of share trades should be increased to 100s lots at least.

Unless you are on top of a down move by shorting shares or whatever, the backspread will start to lose near the strikes, especially the long strike.

Furthermore, maintaining neutrality is easier said than done. If you are proposing trading shares to maintain neutrality, then you risk whipsaw action that will eat away any profit. You also risk a big move in either direction that could produce a loss.

(note : I didn't see dest's post until after I wrote this. It sounds like he knows what he's talking about, but I'm not sure:()
 
Swole15 said:
I have been researching ways to profit from index skew changes and the research paper below has some good information.

http://www.mat.ucm.es/~ivorra/papers/TFMAG.pdf

The paper points to the fact that index skew gets steeper as expiration approaches. I am trying to think of a way to make consistent profits from this phenomenon and this is what I am thinking:

+3 SPY Nov 15 Puts at 185
-2 SPY Nov 15 Puts at 190
- 3 shares of SPY

Greeks at origination:

Delta: .16
Gamma: -.41
Theta: -.46
Vega: -.36
Rho: .58

Skew at origination:

-.022 / .025 = -.88

I would keep this close to delta neutral until a profit target is met. Has anyone used something like this or sees a problem with the strategy? Thanks in advance, I'm fairly new to option trading so any input is definitely welcome.
More...

Before you waste your time and money, my 2 cents,
Check if your "skew edge " still there after you take into the commission and slippage in the real trading ?
 
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