SPX Credit Spread Trader

[dojiboy007]

Quote from optioncoach:

Thanks! I will look into it. Even so, we are talking about spikes up to the 40s to 80s on major nasty nasty crashes and those few points will not change the end result we are trying to get at.

Not a trivial issue imo. The relationship between index/stock and future that we are all accustomed to does not exist with VIX. Only close to expiry will vix future CLOSELY mirror the index. A far month VIX option could have a relatively muted response to a spike in VIX index. This could affect your decision on how far out to buy protection.

 

[El OchoCinco]

Well personally I am a fan of doing it perhaps month to month and pay as little time value as possible and match the cost with monthly income. Your response is another reason I would favor doing it that way as well.

But I would still assume that if the VIX spiked to 60, the VIX options would still have to move significantly to provide the hedge one is looking for. My preference is for short-term insurance each month if needed.

Quote from dojiboy007:

Not a trivial issue imo. The relationship between index/stock and future that we are all accustomed to does not exist with VIX. Only close to expiry will vix future CLOSELY mirror the index. A far month VIX option could have a relatively muted response to a spike in VIX index. This could affect your decision on how far out to buy protection.

 

[andysmith]

Rallymode,

I'm debating about the monthly insurance versus buying, say, a whole year's worth at one time. The problem with the latter is that it will not react to a VIX pop nearly as much as a front month option...

Quote from rallymode:

coach,

i read an article when the vix options first came out regarding their use and the number one reason was hedging portfolios from 9/11 type events.......

.... it would make more sense to pay out the insurance for the whole year upfront, rather than do it month after month. For example, may 20 calls are .30 with 42 days of protection when the aug are .60 with 133 days of protection (2 times more expensive, 3 times the protection).

 

[ryank]

Quote from andysmith:

Rallymode,

I'm debating about the monthly insurance versus buying, say, a whole year's worth at one time. The problem with the latter is that it will not react to a VIX pop nearly as much as a front month option...

Once I read #5 on cboe I thought the same thing, you have to keep the time frame as short as possible so that it has a better chance of mirroring the spot VIX.

ryan

 

[rallymode]

Quote from andysmith:

Rallymode,

I'm debating about the monthly insurance versus buying, say, a whole year's worth at one time. The problem with the latter is that it will not react to a VIX pop nearly as much as a front month option...

after reading some more on the topic(yes that dreaded #5) of how vix options will react to a change in the underlying and price at expiration compared to current price, i am not so sure of the merits of either one. What i mean is that since an increase in the vix will not ensure an increase in the call prices since clal prices will reflect the expected vix at expiration. And since the VIX always falls sharply after a big move up then those calls may actually not even budge if say u have 2-3 weeks to expiration.

It's purely a speculation as we have to go through an actual event to see how it goes but i am not as sure as i was earlier about the merits since we have no hard data to back it up and onyl speculations.

 

[El OchoCinco]

I still think that the VIX call options at 20 have to move if the VIX spikes to 60 because there would be HUGE arbitrage out there for institutions that can use VIX futures. I am sure they can come up with some model to play this lol.

Also when VIX spikes, it comes down only when the uncertainty factor is removed a bit. THe options will not know for certain VIX will pull back since there is uncertainty at the time and therefore will jump as well. They will fall once VIX falls which occurs once the crash is processed or news is absorbed. In the meantime, you will get a surge in the price of the VIX options.

This is not a perfect 1:1 hedge vehicle. It is an insurance policy for major spikes in VIX and despite the forward volatility estimations, a huge SPIKE will not mean that the option pricers simply leave them as they are expecting a pull back in VIX. When the major terrorist event occurs or the market crashes 300 points (DOW), no one knows when it will stop or reverse so the uncertainty factor will cause those calls to also jump in value.

Best bet is to use front-month options to get the most bang for the buck.


EDIT: Also notice that all ITM calls have time value premium and so do ITM puts going out to FEB 07. I have to assume that if VIX hit 80, the 20 Calls would have to be worth at least 60 or so.

Quote from rallymode:

after reading some more on the topic of how vix options will reaction to a change in the underlying and price at expiration compared to current price, i am not so sure of the merits of either one. What i mean is that since an increase in the vix will not ensure an increase in the call prices since clal prices will reflect the expected vix at expiration. And since the VIX always falls sharply after a big move up then those calls may actually not even budge.

It's purely a speculation as we have to go through an actual event to see how it goes but i am not as sure as i was earlier about the merits since we have no hard data to back it up and onyl speculations.

 

[gpe]

Phil,

Great thread - I recently discovered ET, and have gotten as far as October 2005 in this journal, and decided to jump ahead.

Perhaps you've covered this earlier, but can you comment on why you now favor credit spreads as opposed to put ratio spreads. In one of your earlier posts you allude to the fact that you used to do put ratio spreads, but decided to switch to straight credit spreads.

GPE

 

[Cache Landing]

I think for me what it boils down to is that it is a fairly decent way to exit your dangerous positions the day of (or the day after) a black swan event. This is not a hold until expiration and come out with a minimal loss type of hedge. If the crash happened with say 4 weeks to expiration, we might be able to assume that there would be a sufficient VIX increase to limit our losses. But we can also assume that during the follow couple weeks there is a chance that it will fall back.

 

[rallymode]

Quote from optioncoach:

I still think that the VIX call options at 20 have to move if the VIX spikes to 60 because there would be HUGE arbitrage out there for institutions that can use VIX futures. I am sure they can come up with some model to play this lol.


EDIT: Also notice that all ITM calls have time value premium and so do ITM puts going out to FEB 07. I have to assume that if VIX hit 80, the 20 Calls would have to be worth at least 60 or so.

I am not trying to spoil the party, but to be honest i am not so sure if that is a guaranteed scenario.

For arbitrage to occur between the futures and the options if VIX spikes and premiums stay the same that implies that futures premiums won't be skewed which they can very well be just like they are skewed prior to ex-divs or major news events.

Also, since sharp VIX spikes always result in sharp drops, selling call spreads or buying puts would be hugely profitable. Thus, i think there will be a discrepancy which we cannot anticipate at this time. I am sure that the MM's won't allow us to sell hugely inflated calls.

I'd be the first to sell call spreads if vix calls are at 80+
Again, its just speculation.

 

[El OchoCinco]

Only as far as OCT 2005? It starts getting REALLLLLLY GOOOD right after that...

I was doing put ratio spreads on GOOG and DJX for some time taking in small credits. After a while, the margin requirement was getting too big if I wanted to scale up and the credits were not so great, given the naked put risk. Even though my absolute margin now is higher because I am doing larger positions, I feel like I am getting more credit for the risk and the SPX lets me go further OTM in many cases. GOOG credits started drying up far OTM as it took off and kept going higher and then the wild swings every once in a while made me want to get away from specific stock risk.

I was dabbling in SPX spread and decided to keep increasing my use of them and voila... here we are

Quote from gpe:

Phil,

Great thread - I recently discovered ET, and have gotten as far as October 2005 in this journal, and decided to jump ahead.

Perhaps you've covered this earlier, but can you comment on why you now favor credit spreads as opposed to put ratio spreads. In one of your earlier posts you allude to the fact that you used to do put ratio spreads, but decided to switch to straight credit spreads.

GPE