SPX Credit Spread Trader

I think that the fact that you are in a spread position, the effects of vega and delta are partially offset to an extent. To flesh this out I did an experiment using Black-Scholes and the SPX.

Assumptions:

SPX @ 1215
Put Spread 1160/1170
IV at 13.01%
November Expiration - 49 Days

Using B-S, the spread value for 1160/1170 would be $1.90.


Now focusing on IV, I assumed IV increases of 30% and 50%, keeping all other factors constant including time and index value.

30% Increase in IV to 16.91% = $2.50 Spread Value
Result is 32% increase in Spread Value

50% Increase in IV to 19.51% = $2.85 Spread Value
Result is 50% increase in Spread Value

Now focusing only on delta/gamma I assumed index moves to 1185 and kept time and IV constant.

Index at 1185 = $3.60 Spread Value
Result is 89% increase in Spread Value

Now to factor in how IV would also affect such a move, I assumed index again at 1185 but increased IV 30% and 50%:

Index 1185, IV @ 16.91% = Spread Value of $4.00
Result is that IV increased spread value 11% over delta change and 110% over original Spread Value.

Index 1185, IV @ 19.51% = Spread Value of $4.10
Result is that IV increased spread value 14% over delta change and 116% over original Spread Value.

SO what are my conclusions from this experiment?

1. All things kept constant, increases in IV does have a negative effect on the value of your credit spread. But this makes sense since if all things are constant a change in IV would have to affect your spread. However if IV increased over time and all other things were constant, theta would slightly reduce the effects of IV increases. If the index moved away from your short strike and IV icnreased, then theta and delta would offset vega. Nonetheless it is a risk factor to consider.

2. If the index moves against you and all other things are constant, the effects on your spread from delta seem more significant on average than changes in IV. However if time were factored in theta would chip off some of the delta effects but only slightly.

3. If the index moves against you AND IV increases 30% or 50%, the negative effects of delta/gamma greatly outweight the effects of vega on the value of your spread. Delta alone cause the spread to increase dramatically in value. When a simultaneous increase in IV was factored in, the increase in the price of the spread was minimal compared to the delta effect.

3. Vega and Delta are both individual risk factors in selling credit spreads. Delta is more dangerous since delta comes with a negative move against you which is what could lead to losses shoudl the index move past your short strike. IV increases alone result in a paper loss but are not significant if the index is flat or moves away from your short strikes since delta and theta combine in your favor. In the case where the index moves against you and IV also increases, the most damage will come from the delta change of your spread then the vega change of your spread.

4. Delta is the greatest risk factor because of the potential for the short strike to be ITM. Therefore, risk management decisions should focus on reducing the liklihood of short strikes being ATM or ITM. This includes, rolling short strikes down to obtain more distance to allow your short strike to remain OTM, adding long deltas in the form of SPYs, SPX longs, E-mini futures, and related products at the appropriate time, or combining long and short spreads in some fashion to reduce the net deltas.

Hope this helps in examining further the risks of OTM credit spreads.

Phil
 
Phil,

This is a very helpful analysis. By the way, I know tat you used a fly to hedge your put spreads recently. Do you recall if that had an effect on overall (ie. position) delta?
 
Hi Coach,

Please help me here. I have studied the math behind options and fully understand the "greeks".

In the past, I have bought and sold lots of options based on the greeks, and a huge swing in the market that impacted the underlying made all that analysis worthless (I lost money).

Do you or anyone you know actually make money by analyzing and trading on the greeks?

The greeks change radically as the underlying changes. I have found my time is better spent focusing on fundamental and technical analysis of the underlying...have you also found this to be true?

I appreciate your sharing your thoughts.

modegolf
 
If you look at straight delta as of today, the SPX spread (1165/1175) has a net delta of -.02 while the SPY butterfly has a positive delta of .07.

However I have 110 SPX spreads and only 30 SPY FLYs so the scales are quite different and the SPY FLYs probably have little or no effect on net deltas initially. Where the effect is really felt is if the index starts to move below the upper wing of the FLY as expiration approaches. The FLY profit will either add to my overall profit or provide a cushion to allow me to adjust using hopefully the FLY profits to offset costs of adjusting. BUt this is more effective when expiration is close given the nature of FLYs and that is why I used the 120/117/114 strikes because it was a move between 1200 and 1175 I was concerned with.

The FLY or other SPY hedges is not really gonna hedge my deltas because to fully hedge my deltas the SPY, or even using SPX to do it, costs would wipe out the benefit of my credits. So my goal with the hedges is to have a way to make some money on an adverse move so that those profits can finance the adjustments and keep my profits protected or cushion a loss I might need to take to close out the position entirely.

Now with the mini-SPX I would really like to play with those and see what interesting combinations I can come up with.

Phil

Quote from andysmith:

Phil,

This is a very helpful analysis. By the way, I know tat you used a fly to hedge your put spreads recently. Do you recall if that had an effect on overall (ie. position) delta?
More...
 
Here is my OPINION on the GREEKS. They are important to study and understand since doing so truly helps you understand how options work, how they are priced to an extent and what factors affect the price of an option, and finally what are the strengths and risks of each strategy.

As for trading, I believe that only the market makers and institutions with huge portfolios and little or no transaction costs and the need to constantly hedge can truly use the greeks effectively daily to hedge and monitor their portfolios. Traders like us can use greeks to monitor positions but I do not think we can trade solely based on the Greeks.

For example, delta-neutral hedging a straddle is quite costly depending on how often you re-balance. Adding stock to a straddle at a certain time to hedge once is certainly viable but not a steady stream of trades to keep it delta neutral. Also straddles look for the larger price move and it either happens or it doesn't so a stop loss and profit plan is the best way to manage the position based on how the underlying moves.

In credit spreads, basically I want the posiiton to expire worthless or buy it back for way less than I sold it for. The greeks are important to understand what happens to the spread over time as the index moves, but I am not adjust the position based solely on the greeks, I am gonna use my analysis of the underlying index to determine whether I should roll out our close.

That is one reason in my book on adjustments we did not focus on using the Greeks to make adjustments, we focused on the risk and reward. Because the focus is on limiting your losses and taking profits and the adjustments covered focused on that- limiting your loss, locking in a profit, hedging the position from a loss, etc. We discussed the Greeks because as I said you need to understand how time, volatility and moves in the underlying affect your position and what factos presents the most risk (i.e. vega and theta in long straddles), but my OPINION is that you do not need to know the actual values to make hedging or adjustment decisions. Market makers and institutuins can but most retailer traders need to focus on risk and reward to effectively manage risk.

Initially one can focus on detlas such as when constructing a ratio backspread or other type of ratio spread and I do find that is an effective tool to creat an good opening position. But not to follow it daily and re-adjust those deltas.

This is my view and also from what I have seen from many traders. Gamma scalping and delta hedging are better left to those with minimal costs like the MMs and institutions. Except for one time adjustments in certain situations or using them to open a posiiton (i.e. creating a delta neutral position at the opening of a ratio backspread and adding or subtracting calls after a significant move) trading purely through the greeks might not do the retail trader much good.

Phil

Quote from modegolf:

Hi Coach,

Please help me here. I have studied the math behind options and fully understand the "greeks".

In the past, I have bought and sold lots of options based on the greeks, and a huge swing in the market that impacted the underlying made all that analysis worthless (I lost money).

Do you or anyone you know actually make money by analyzing and trading on the greeks?

The greeks change radically as the underlying changes. I have found my time is better spent focusing on fundamental and technical analysis of the underlying...have you also found this to be true?

I appreciate your sharing your thoughts.

modegolf
More...
 
Skdoyle1,

If you don’t mind, what is the additional option service you are subscribing to? I wouldn’t mind following what other option professionals are doing as well as the ones that share their thoughts/trades on this sight. It might provide me w/ some insight.

Thank you for your help.
 
Hi Coach,

As always, great thread!

You have shared your approach for getting good fills, but I have not seen in the thread where you discuss your closing out approach.

Do you use the same approach when closing a position (shoot for the midpoint then shave off a nickel or a dime)?

Thanks for your help,

modegolf
 
Phil,

Appreciate the great threads.... thanx. I have noticed in the past six months trading SPX credit spreads, that in the last week of expiration, trying to close far OTM positions is strange.

It feels like there is NO time decay in the last week of expiration, except on the last day and usually in the last few hours. What I mean is... the spread amount being asked to close an OTM position is say .30, and you attempt to close it for say .20. It's really not worth .05, but the debit spread value doesn't change until the last day.... so in essence... you're receiving no time decay until your position expires.... and all of it on the last day. Is this what you're experiencing also?

This said... I think your stance on rolling out to the next month a week prior to expiration is an excellent risk management approach. Allthough it costs you commissions to close the positions, you gain two benefits (besides sleep). First, you receive time decay for the week... second, you rduce your risk by not being exposed to a position with little time remaining to make any needed adjustment should market conditions dictate.

Is this what you have experienced?

Murray
 
When closing a position I do use the same approach however I can afford to be more aggressive. If I see a significant profit I can place a more aggressive split between the b/a and just leave the order there all day. If I get filled, great. If not, I can simply try again the next day and allow one more day of decay. I am not in a rush to claim the profit so I can be more aggressive and give it time to get filled.

Phil

Quote from modegolf:

Hi Coach,

As always, great thread!

You have shared your approach for getting good fills, but I have not seen in the thread where you discuss your closing out approach.

Do you use the same approach when closing a position (shoot for the midpoint then shave off a nickel or a dime)?

Thanks for your help,

modegolf
More...
 
Murray:

I think what you are experiencing is just the tough b/a spreads on SPX that last week but simply put the order in and let it sit for a while and you might get filled. If you are that far OTM with like 3 days left, it may be better to just let it expire worthless and move on to the next position on Friday after settlement.

My desire for rolling before expiration is more to take advantage of time in the next month since I like to jump in with about 45 days to expiration and before expiration is when the next month is around that time period. For example, right now NOV is looking good, but I still have my OCT positions open so will be looking to close one of my OCT for a profit to open a good position. I have some margin available but as much as I would like. I do not mind waiting until expiration if none of my spreads have a significant profit to take. But it is always easier to wait until expiration if those positions are far enough OTM that a last minute move will not cause me to have to adjust.

Phil


Quote from Sailing:

Phil,

Appreciate the great threads.... thanx. I have noticed in the past six months trading SPX credit spreads, that in the last week of expiration, trying to close far OTM positions is strange.

It feels like there is NO time decay in the last week of expiration, except on the last day and usually in the last few hours. What I mean is... the spread amount being asked to close an OTM position is say .30, and you attempt to close it for say .20. It's really not worth .05, but the debit spread value doesn't change until the last day.... so in essence... you're receiving no time decay until your position expires.... and all of it on the last day. Is this what you're experiencing also?

This said... I think your stance on rolling out to the next month a week prior to expiration is an excellent risk management approach. Allthough it costs you commissions to close the positions, you gain two benefits (besides sleep). First, you receive time decay for the week... second, you rduce your risk by not being exposed to a position with little time remaining to make any needed adjustment should market conditions dictate.

Is this what you have experienced?

Murray
More...
 
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