SPX Credit Spread Trader

[El OchoCinco]

Lots of good points on the VIX issue, but my opinion is that a huge immediate spike will still result in a large move in the VIX calls which will provide partial insurance against the spread losses in a huge move lower. As Cache said, this is not a locked in hedge. If the VIX spikes, the idea is to sell the calls to take in the profits and close out your spreads if the large move lower hurts you. Although it is speculation, a 20 Call priced at $0.35 cannot barely budge when the VIX has spiked to 60.

If VIX was forecasted to increase over the next 6 months or so, for example, the ITM puts would trade at a slight discount but they trade at their intrinsic value to buy at a minimum. I cannot forecast what the exact option values would be on a spike to 60, but my opinion is that it would have a huge surge as well, even if it is known VIX moves back lower, the point is no one knows when. However the fact that these VIX options are worth at least their intrinsic value leads me to believe that there will still be a significant move in the options.

 

[rallymode]

Quote from optioncoach:

Lots of good points on the VIX issue, but my opinion is that a huge immediate spike will still result in a large move in the VIX calls which will provide partial insurance against the spread losses in a huge move lower. As Cache said, this is not a locked in hedge. If the VIX spikes, the idea is to sell the calls to take in the profits and close out your spreads if the large move lower hurts you. Although it is speculation, a 20 Call priced at $0.35 cannot barely budge when the VIX has spiked to 60.

If VIX was forecasted to increase over the next 6 months or so, for example, the ITM puts would trade at a slight discount but they trade at their intrinsic value to buy at a minimum. I cannot forecast what the exact option values would be on a spike to 60, but my opinion is that it would have a huge surge as well, even if it is known VIX moves back lower, the point is no one knows when. However the fact that these VIX options are worth at least their intrinsic value leads me to believe that there will still be a significant move in the options.

coach,

here is what i am talking about in numbers. Again, it is speculative in nature as we have no hard data to back it up. Let me use the model that MM's use when pricing futures prior to ex-divs.

Point#1

Say you buy the 20 calls at $.30 today and tomorrow there is market crash that takes the VIX to 60. Here is what can happen due to the ALMOST certain drop in VIX in the near future.

The options could be priced as follows:

May 20 calls - BID/ASK 30/60

Also the VIX futures could be priced similarly which you can certainly buy into the position at intrinsic but cannot get out or sell short at intrinsic. Futures before dividends are always priced this way to discourage arbitrage.

Point#2

Since its expected that long term VIX options won't increase as much or any then this would imply the following.

with VIX at 60 - APR 20 calls at 60, May 20 calls at 50?? I dont think this will happen as thats the arbitrage you are talking about. Longer term option will never be cheaper than shorter term. Thus i believe the bid/asks will be skewed with a huge spread.

Point#3 VIX futures will probably be selling at a discount as again MM's won't allow us to short them and make easy money.

I am more inclined to believe that the prices will be skewed in a big way and the bid/ask discrepancies will eliminate most of the profit if not all. That would be the only way to eliminate arbitrage or nearly certain profits. Like i said, if i can sell my 20 calls at 60, you can bet i'd be seeling calendars or bear call spreads with every cent that i have.

Good discussion nevertheless.

 

[RichardRimes]

Quote from optioncoach:

OK folks here is the Black Swan Insurance Plan my friend discussed with me and I want to share it with you.... cause that is the kind of Coach that I am Remember this is for large major nasty moves lower.

Now that the VIX has options trading, we can use them to insure our spreads against Black Swan events.

First, since VIX is newer, let's look at a chart of VXN going back to its beginning in 2001:

Notice the period around 9/11 where VXN spiked to to 90 and also notice where the VXN spiked to 70 during some other market drops in 2002. Assume that VIX existed as well and it would have had the same moves on a really nasty event or drop in the market.

Now let's look at the new VIX options which started trading in February I believe:

Now assume that I put on a MAY position with way OTM put strikes, about 80 - 90 points and I take in a credit of $12,000 with my usual positions. I then take about $3,000 and purchase 120 VIX MAY 20.00 Calls at $0.25 for $3,000. Net credit is about $8,000 at worst after all commissions (just using worst case), and you have a pocket insurance policy.

If something nasty occurs and the market drops (post Katrina VIX got close to 20 and this was not a Black Swan type of event), the VIX will skyrocket well above 20. Assume the market falls 50 points or so quickly on some nasty shit and the VIX jumps to 42. Your 20 strike calls will be worth at least $22.00 *120 *100 = $264,000.

That will pretty much cover most, if not all of your potential loss on the spreads which most likely will not even be ITM yet but quite expensive due to delta/gamma and IV. So it will not be at full value but pricey enough. With the VIX option insurance proceeds + your initial credit, you have enough to close out the position with a hair of loss at worst and you survive the Black Swan event.

You could buy these each month as you open put spreads or look out longer term and maybe in April or MAY spend some profits on longer-term calls and let them sit.

You could do bull call spreads to get a cheaper cost with fixed insurance payout. In other words if you can get the 17.50/20 bull call spread for $.15 then you can do 200 with a max payout of $2.50 per spread. I think it is better just to go long the calls.

THIS WILL NOT WORK IF MARKET BLEEDS LOWER TO YOUR SHORT STRIKES like in post Katrina. Although VIX jumped it did not explode even though the market moved like 50+ points. This insurance is only for the huge 9/11 or nasty market plunge that is sudden and nasty.

So there it is folks.... the Coach Phil (copied from his friend) Black Swan Insurance Plan

celerypoo....in case ppl want to check it out later

 

[El OchoCinco]

1. I will take a 30/60 bid/ask spread if I spent $0.30 on the Call. In my earlier example, even getting out at $30.00 is a profit on 120 calls of $360,000..... I could probably shave a little of that ask too.

2. "...with VIX at 60 - APR 20 calls at 60, May 20 calls at 50"

With VIX at 60, APR 20 Calls will be around $40 and MAY 20 calls will be slightly more but both will be DEEP ITM. If GOOG is at $390 the $300 Calls for ARP and MAY will both be pretty close to intrinsic value. The fact that VIX options are based on forward values and not spot, would only change this slightly in the b/a spreads. MMs cannot "know" that VIX will come down immediately, within 2 weeks or within 3 months and to what magnitude it will come down. Spot and forward rates are handled in the interest rate and forex markets and they deal with the same issues. A large spike in the value of the Euro will cause spot to go up and the next month forward will go up almost as much, even if the value is expected to come down- the question is when and by how much. Uncertainty...

3. Again, it makes no sense that a long 20 strike call bought at $0.30 will have no profit with the VIX spiking to 60. Forward or not, VIX spiking means volatility and uncertainty have gone off the normal range and even MMs will not have any idea if it will come down or when. If thye underprice options and VIX does a double spike like it did after 9/11 and it did in early 2002 with a prolonged 3 month spike.

EXCELLENT DISCUSSION BY THE WAY

Quote from rallymode:

coach,

here is what i am talking about in numbers. Again, it is speculative in nature as we have no hard data to back it up. Let me use the model that MM's use when pricing futures prior to ex-divs.

Point#1

Say you buy the 20 calls at $.30 today and tomorrow there is market crash that takes the VIX to 60. Here is what can happen due to the ALMOST certain drop in VIX in the near future.

The options could be priced as follows:

May 20 calls - BID/ASK 30/60

Also the VIX futures could be priced similarly which you can certainly buy into the position at intrinsic but cannot get out or sell short at intrinsic. Futures before dividends are always priced this way to discourage arbitrage.

Point#2

Since its expected that long term VIX options won't increased as much or any then this would imply the following.

with VIX at 60 - APR 20 calls at 60, May 20 calls at 50?? I dont think this will happen as thats the arbitrage you are talking about.

Point#3 VIX futures will probably be selling at a discount as again MM's won't allow us to short them and make easy money.

I am more inclined to believe that the prices will be skewed in a big way and the bid/ask discrepancies will eliminate most of the profit if not all.

Good discussion nevertheless.

 

[rallymode]

Quote from optioncoach:

1. I will take a 30/60 bid/ask spread if I spent $0.30 on the Call. In my earlier example, even getting out at $30.00 is a profit on 120 calls of $360,000..... I could probably shave a little of that ask too.

that $30 was purely speculative, it could easily be only $20.30 which means u make nothing.

Quote from optioncoach:



2. "...with VIX at 60 - APR 20 calls at 60, May 20 calls at 50"

With VIX at 60, APR 20 Calls will be around $40 and MAY 20 calls will be slightly more but both will be DEEP ITM.

i am sorry my math was wrong. I meant with vix at 60, the MAY 20's would be 40 not 60. But per your post if next months are slighly more than the #5 disclosure on the CBOE with regards to premeiums on longer term options makes no sense and its better to buy the whole year in advance since long term options will move just as much, NO?

See, i truly believe that the MM's will skew the bid asks and discoutn the futures to eliminate the easy money.

Quote from optioncoach:


3. Again, it makes no sense that a long 20 strike call bought at $0.30 will have no profit with the VIX spiking to 60. Forward or not, VIX spiking means volatility and uncertainty have gone off the normal range and even MMs will not have any idea if it will come down or when. If thye underprice options and VIX does a double spike like it did after 9/11 and it did in early 2002 with a prolonged 3 month spike.

not underprice them, skew them. what makes you think that if the bid/ask is at 20/60 which is possible, you will be able to be filled midpoint by a MM?? Try getting filled midpoint on a ES spread and tell me how successful you were.

 

[El OchoCinco]

Want to get into MAY already so I closed my 350 SPX 1225/1235 bull put spread for a debit of $0.20 and a profit of $0.15 or $5,250


Here is my updated positions:


SPX CALL DIAGONAL SPREAD (OPEN):

- 8 SPX APR 1340 Calls @ $4.70
+ 10 SPX MAY 1375 Calls @ $3.10

Net Credit = $660

Unrealized profit of about $1,000 for now but gonna let it run and make more off of it if I can.



SPX BULL PUT SPREAD (CLOSED):

- 350 SPX APR 1225/1235 Put Spreads @ $0.35

Net Credit = $12,250

Closed for net credit of $0.15 or $5,250



PUT SPREAD PARTIAL HEDGE (OPEN- and the reaons we are bullish lol):

+ 100 SPY APR 126/125 Put Spreads @ $0.10

Net Debit = $1,000


[Not including prop trades here because my head cannot keep all this straight!]

 

[El OchoCinco]

Quote from rallymode:

that $30 was purely speculative, it could easily be only $20.30 which means u make nothing.

Eplain how I make nothing when I buy a long call for $0.30 and sell it for $20.30?????

not underprice them, skew them. what makes you think that if the bid/ask is at 20/60 which is possible, you will be able to be filled midpoint by a MM?? Try getting filled midpoint on a ES spread and tell me how successful you were.

I never said MID-POINT lol, I said if the b/a is $30/$60, I could try and get $40 or $35 and still get out pretty nice for an option I paid $0.30 for.

P.S. also arent, the ES spread apart by one tick so there is no b/a to spread really or did I misunderstand..

 

[ChrisM]

Quote from optioncoach:

1. I will take a 30/60 bid/ask spread if I spent $0.30 on the Call. In my earlier example, even getting out at $30.00 is a profit on 120 calls of $360,000..... I could probably shave a little of that ask too.

I am not an expert....sorry

Let`s assume that 20Calls are 20 points ITM and spread is killing.

How about selling short futures against calls ? You are covered on upside, but if vola goes down you don`t need to touch options, just realize profits on futures.

 

[rallymode]

Quote from optioncoach:

Eplain how I make nothing when I buy a long call for $0.30 and sell it for $20.30?????



I never said MID-POINT lol, I said if the b/a is $30/$60, I could try and get $40 or $35 and still get out pretty nice for an option I paid $0.30 for.

1. Well, again my math is wrong, its been a busy morning at work. in that case make the bid .30 and ask 60. Better yet, make the bid at $0.(yes zero, go look at the vix 10 puts, u cannot find a single bid anywhere)

Sounds impossible but whats the alternative? Calls with the bid at $60? and VIX futures with bid of 60?? I can sell the futures and buy ATM calls and make tons. Again, if crash happens, i think the usual option pricing models will not apply because of the opportunity for arbitrage that will exist due to the fact that VIX always falls after a spike. Doesnt matter if its days or 3 months, i can go LEAP and still make tons of $$$$ with lil to no risk.

2. What i mean was that you wont be able to get filled anywhere between the bid/ask. It sounds unreasonable but i've seen it happen on many instruments ES options, SSF's, etc. As a matter of fact go and try to sell Feb 07 vix 10 puts mid point or not, you wont be able to sell as there are no bids.

If the bids on VIX options follow norman option pricing models then i'd be the first to mortgage the house and become filthy rich over a short period of time. That's the main reason i believe prices will be skewed and thus that position may not make much if any.

I think a MM can answer this better as to how it may be priced as they always priced instruments against arbitrage and easy money. Anyone know any MMs?

Quote from ChrisM:

I am not an expert....sorry

Let`s assume that 20Calls are 20 points ITM and spread is killing.

How about selling short futures against calls ? You are covered on upside, but if vola goes down you don`t need to touch options, just realize profits on futures.

this is precisely what i mean. Mortgage the house and retire in a month.

 

[El OchoCinco]

I know we are speculating, but even without a model I have to disagree that a 20 call would stay under $1.00 with a few weeks to expiration and the VIX spiked to 60. Those calls have to have some value in line with the VIX move although it will not be 1:1.

Without an option pricing model I think I can say for sure that the 20 call will have considerable value with the VIX at 60 or some other huge spike value. And that will produce a significant profit on a $0.30 call to insure, partially or fully, your put spreads with a market crash.

It is a pretty cheap insurance policy for considerable profit on a VIX spike which usually accompanies the market crash that would come from a Black Swan event.

Also, why would you mortgage the house on something that has risk... you need the VIX ti psike first. Without that you lose money.

Quote from rallymode:

1. Well, again my math is wrong, its been a busy morning at work. in that case make the bid .30 and ask 60.

Sounds impossible but whats the alternative? Calls with the bid at $60? and VIX futures with bid of 60?? I can sell the futures and buy ATM calls and make tons. Again, if crash happens, i think the usual option pricing models will not apply because of the opportunity for arbitrage that will exist due to the fact that VIX always falls after a spike. Doesnt matter if its days or 3 months, i can go LEAP and still make tons of $$$$ with lil to no risk.

2. What i mean was that you wont be able to get filled anywhere between the bid/ask. It sounds unreasonable but i've seen it happen on many instruments ES options, SSF's, etc.

If the bids on VIX options follow norman option pricing models then i'd be the first to mortgage the house and become filthy rich over a short period of time. That's the main reason i believe prices will be skewed and thus that position may not make much if any.

I think a MM can answer this better as to how it may be priced as they always priced instruments against arbitrage and easy money. Anyone know any MMs?



this is precisely what i mean. Mortgage the house and retire in a month.