SPX Credit Spread Trader

[jeffm]

The P/L of a put diagonal comes from the value remaining in the long backmonth option when the short frontmonth expires. Obviously the value of the underlying is important to the long option value. But the volty is also critical. If you put the trade on during high vol, and the trade ends with low vol, your long option will get the volatility crush. If you enter with low volatility, you have some measure of protection from the volty crush. Plus if volty increases during the trade it helps your long option.

Murray said he entered when SPX was around 1265, which would have been in early July. VIX at that time was in the 14 range, which was pretty low compared to the recent range. The trade doesn't necessarily need volty to increase, but you sure don't want it to plummet. Hence you enter when VIX is low.

SPX versus ES doesn't matter, except in the technical details of getting the order filled, margin, etc.

Quote from rdemyan:

I'm not sure I understand the benefit of putting the trade on when the VIX is low at least when entering the trade.

 

[Prevail]

Murray, thank you for your detailed synopsis; I know that took some time.
I have a question if you are up for it. at some point this month the short 1250's were in the money and perhaps will be today at x. do you have an exit to limit losses if the short losses start mounting and overcoming the gains of the long?

if you don't have time to respond i'll just imagine you are winning the race with the wind in your hair.

 

[rdemyan]

Thanks, Jeff.

Your clear explanation helped resolve a few questions that I had.

Quote from jeffm:

The P/L of a put diagonal comes from the value remaining in the long backmonth option when the short frontmonth expires. Obviously the value of the underlying is important to the long option value. But the volty is also critical. If you put the trade on during high vol, and the trade ends with low vol, your long option will get the volatility crush. If you enter with low volatility, you have some measure of protection from the volty crush. Plus if volty increases during the trade it helps your long option.

Murray said he entered when SPX was around 1265, which would have been in early July. VIX at that time was in the 14 range, which was pretty low compared to the recent range. The trade doesn't necessarily need volty to increase, but you sure don't want it to plummet. Hence you enter when VIX is low.

SPX versus ES doesn't matter, except in the technical details of getting the order filled, margin, etc.

 

[rallymode]

Quote from Prevail:


I have a question if you are up for it. at some point this month the short 1250's were in the money and perhaps will be today at x. do you have an exit to limit losses if the short losses start mounting and overcoming the gains of the long?

I was thinking the same thing but did not want to open a can of worms. The profile of diagonals makes it prudent to wait until the last few days to make any adjustments if you want to book your gains. The problem in my opinion becomes when the market goes through your short and towards your long side. Sure the volty increase will cushion you somewhat but if there is too much time in your short strike left, you are in a alot of pain as the volty will affect that side as well. The depth of adjustments available to the strategy shouldnt be why one might favor diagonals as adjusting is rarely the better choice over a simple offset.

As any other strategy, you best choose the strikes and distances between them right. Nevertheless, if market and volty forecast turn out true, one will see some nice gains. That's my two cents.

 

[RichardRimes]

what was set? thx for the last couple of months for whatever I'm not getting it from the CBOE until much later.

 

[RichardRimes]

1251.72 TOS released margin before they announced set....

 

[jeffm]

Just a reminder of Murray's position:
Position #3
STO July 1250p - $20.00 STC July 1250p - expired, pending SET
BTO Aug 1230p - $20.90 BTC Aug 1230p - $13.20

Ignoring that SET was 1251, lets just play with the numbers...

Lets assume SPX drops to 1230 today. Where would this diagonal end up?
Short 1250P loses 20 pts.
Initial debit was 0.90 pts.
The question then becomes, "what is the value of the AUG 1230P?"
SPX is currently 1240, so I'll just use the AUG 1240P as a ballpark value for the ATM 1230P if SPX dropped to 1230.
SPX 1240P is 18x20, so lets just call it 19. If we did drop another 10 pts, the volty bump would help the long put, but we'll ignore that for simplicity.

So the final trade value is (20) + (0.9) + 19 = (1.9)

I'm gonna say that's not too bad for a suprise 1 day move where the market plunges 20 points below your short.

As rallymode alluded to, a drop to your short strike that happens with two weeks remaining is much more painful.

If the market closed right here at 1240, the AUG1230P is worth 15, so the trade still nets (10) + (0.9) + 15 = 4.1 pts. Still a nice result considering an unpleasant expiration day. Plus the other put diagonals that are expiring OTM will all benefit nicely from this move down.

 

[dagnyt]

Quote from rallymode:

The profile of diagonals makes it prudent to wait until the last few days to make any adjustments if you want to book your gains.

I disagree. It is ANYTHING but prudent to hold these positions through expiration. I tend to close all diagonals early. When I believe the profit is sufficient AND the risk of holding the position is high, I close and open a new position in a further month.

That may not work for everone, but it works for me. I see no need to go for huge profits when risk is ever present.

Mark

 

[rdemyan]

These analyses are very helpful to me in understanding how these diagonals work.

Can we take this one step further. Let's assume a black swan event. Say a 100 point drop from 1250. The 1250 loses 100 points. How do we estimate the value of the August 1230 without a VIX. Can we estimate the VIX value based on the 100 point drop?

Quote from jeffm:

Just a reminder of Murray's position:
Position #3
STO July 1250p - $20.00 STC July 1250p - expired, pending SET
BTO Aug 1230p - $20.90 BTC Aug 1230p - $13.20

Ignoring that SET was 1251, lets just play with the numbers...

Lets assume SPX drops to 1230 today. Where would this diagonal end up?
Short 1250P loses 20 pts.
Initial debit was 0.90 pts.
The question then becomes, "what is the value of the AUG 1230P?"
SPX is currently 1240, so I'll just use the AUG 1240P as a ballpark value for the ATM 1230P if SPX dropped to 1230.
SPX 1240P is 18x20, so lets just call it 19. If we did drop another 10 pts, the volty bump would help the long put, but we'll ignore that for simplicity.

So the final trade value is (20) + (0.9) + 19 = (1.9)

I'm gonna say that's not too bad for a suprise 1 day move where the market plunges 20 points below your short.

As rallymode alluded to, a drop to your short strike that happens with two weeks remaining is much more painful.

If the market closed right here at 1240, the AUG1230P is worth 15, so the trade still nets (10) + (0.9) + 15 = 4.1 pts. Still a nice result considering an unpleasant expiration day. Plus the other put diagonals that are expiring OTM will all benefit nicely from this move down.

 

[rdemyan]

Mark:

How are your fills on the SPX, or have you given up in disgust?

Quote from dagnyt:

I disagree. It is ANYTHING but prudent to hold these positions through expiration. I tend to close all diagonals early. When I believe the profit is sufficient AND the risk of holding the position is high, I close and open a new position in a further month.

That may not work for everone, but it works for me. I see no need to go for huge profits when risk is ever present.

Mark