SPX Credit Spread Trader
- Thread starter El OchoCinco
- Start date
Believe me, your work has not gone unnoticed!
Although I don't trade the SPX and hence VIX is not relevant, I do apply similar thinking to what I do trade.
There have been numerous papers written over the years on whether IV is a better predictor of future volatility than historical volatility and vice versa. I basically fall in line with the school of thought that says that IV represents everything that the market currently knows and therefore is a pretty good predictor. Skewing aside of course.
Therefore, as you allude to, I choose credit spreads based on having >90% probability of the short strike expiring worthless based on the average of ATM IV for the front month rather than using delta as a shortcut. As Andy points out, this is easily accomplished on the TOS platform.
Furthermore, I have performed back of envelope backtesting for adjustment strategies along the same lines. Whereas, Phil has mentioned using 15/10 point warning and trigger levels for heads up and adjusting, for those of you with a slightly more scientific bent you could use the probability based on ATM IV instead e.g. when the probability reaches < 60% you can use that as your trigger to adjust/close. I would like to do more exact backtesting but need to purchase the data which includes option pricing.
The benefit of looking at the probability like this is that it takes into account both IV AND time to expiration whereas looking at a fixed trigger level for when the underlying is near your short strikes does not. [EDIT] There are drawbacks to this approach too lol.
Phil and co obviously have a very good feel for the movement of the SPX and presumably that is where the 15/10 point level has come in, it keeps things easy to understand (KISS etc.) and it works. If underlying volatility does increase significantly then I'm sure that these figures will be updated.
It all boils down to common sense at the end of the day. I'm not sure how mechanical and prescriptive one can make this strategy but I get the feeling that there is great demand to do so and compile a list of 10 commandments!
I eagerly await it's completion.
Momoney.
Although I don't trade the SPX and hence VIX is not relevant, I do apply similar thinking to what I do trade.
There have been numerous papers written over the years on whether IV is a better predictor of future volatility than historical volatility and vice versa. I basically fall in line with the school of thought that says that IV represents everything that the market currently knows and therefore is a pretty good predictor. Skewing aside of course.
Therefore, as you allude to, I choose credit spreads based on having >90% probability of the short strike expiring worthless based on the average of ATM IV for the front month rather than using delta as a shortcut. As Andy points out, this is easily accomplished on the TOS platform.
Furthermore, I have performed back of envelope backtesting for adjustment strategies along the same lines. Whereas, Phil has mentioned using 15/10 point warning and trigger levels for heads up and adjusting, for those of you with a slightly more scientific bent you could use the probability based on ATM IV instead e.g. when the probability reaches < 60% you can use that as your trigger to adjust/close. I would like to do more exact backtesting but need to purchase the data which includes option pricing.
The benefit of looking at the probability like this is that it takes into account both IV AND time to expiration whereas looking at a fixed trigger level for when the underlying is near your short strikes does not. [EDIT] There are drawbacks to this approach too lol.
Phil and co obviously have a very good feel for the movement of the SPX and presumably that is where the 15/10 point level has come in, it keeps things easy to understand (KISS etc.) and it works. If underlying volatility does increase significantly then I'm sure that these figures will be updated.
It all boils down to common sense at the end of the day. I'm not sure how mechanical and prescriptive one can make this strategy but I get the feeling that there is great demand to do so and compile a list of 10 commandments!
I eagerly await it's completion.
Momoney.
THis is one of the drawbacks of the SPX, the wide b/a spread. But I have been told that many market makers trade it and if ytou leave your order up long enough it has a good chance of getting it as long as you are not too aggressive on splitting the b/a. After talking with different people I have found that starting at the mid point and shaving off some nickles and dimes is a good starting point.
I have also been told as you learned that if you can get your broker to call down the order you will certainly get a better chance of being filled. OX has done this for clients and I believe ToS does too.
But I do not think you always need call for fills. If you are patient and let the order sit, the b/a sometimes comes to you.
Phil
I have also been told as you learned that if you can get your broker to call down the order you will certainly get a better chance of being filled. OX has done this for clients and I believe ToS does too.
But I do not think you always need call for fills. If you are patient and let the order sit, the b/a sometimes comes to you.
Phil
I also do not think this can be boiled down to a pure mechanical system. Too many factors require the skill of the trader to make decisions based on current market environment and time to expiration.
I have tried to lay out general guidelines for how I approach this strategy but as can be seen over the months, there I times when I have to go with my experience or instinct and every trader needs to understand that. That is what truly makes one successful. The individual experience and risk management approach. If we made this mechanical and showed it to 10 individuals I bet they would all have different results.
SO I think we can formulate general guidelines and principles, but I encourage every trader doing this strategy or any strategy to learn to adapt when necessary and conform the rules to your own risk and trade management styles.
Phil
I have tried to lay out general guidelines for how I approach this strategy but as can be seen over the months, there I times when I have to go with my experience or instinct and every trader needs to understand that. That is what truly makes one successful. The individual experience and risk management approach. If we made this mechanical and showed it to 10 individuals I bet they would all have different results.
SO I think we can formulate general guidelines and principles, but I encourage every trader doing this strategy or any strategy to learn to adapt when necessary and conform the rules to your own risk and trade management styles.
Phil
Coach, I suspect that you are right, if for no other reason than there are a lot of people who make a living at this game. If we could scientifically establish what would happen in pricing and movement (thereby removing most if not all of the risk), who would want to take the other side (or the premium provided would be so low, we'd be trading something else).
But still, I just plotted the %change in the SPX (y-axis) against the VIX on the x-axis. There is considerable scatter, but I think that one general conclusion I could draw is that if the VIX > 30 the probability of a 2.5% change in the SPX is very high (admittedly there isn't that much data at that VIX). At VIX > 35 it looks more like 4 to 5%.
So if I have a credit spread that I'm planning to hold to expiration, and because of the strikes I selected I'm hoping and praying that the SPX won't change by more than 2%, if the VIX jumps or is already high, I might seriously consider bailing (adjusting might not be enough) simply based on prior historical data. Also, I probably should have used these high VIX levels to adjust my strike selection in the first place.
This is just a first glance look, so I'm not sure. Also, perhaps this is an obvious conclusion to some who haven't even looked at the data.
At the same time, if you look at some of the data if the VIX is around 20 to 30, at first glance it looks like there is as much likelihood that the SPX will move less than 1% as there is that it will move > 4 or 5%. Obviously, as Coach has stated, there are other factors at play. Still I often see many posts here where people espouse how volatility can decimate our credit spreads. I'm not sure that the data bears that out (it probably does if the VIX is > 30 to 35, but I'm not so sure about levels below that). Perhaps we can get a better perspective on how volatility is "likely" to affect us (again, there are other factors to consider).
But still, I just plotted the %change in the SPX (y-axis) against the VIX on the x-axis. There is considerable scatter, but I think that one general conclusion I could draw is that if the VIX > 30 the probability of a 2.5% change in the SPX is very high (admittedly there isn't that much data at that VIX). At VIX > 35 it looks more like 4 to 5%.
So if I have a credit spread that I'm planning to hold to expiration, and because of the strikes I selected I'm hoping and praying that the SPX won't change by more than 2%, if the VIX jumps or is already high, I might seriously consider bailing (adjusting might not be enough) simply based on prior historical data. Also, I probably should have used these high VIX levels to adjust my strike selection in the first place.
This is just a first glance look, so I'm not sure. Also, perhaps this is an obvious conclusion to some who haven't even looked at the data.
At the same time, if you look at some of the data if the VIX is around 20 to 30, at first glance it looks like there is as much likelihood that the SPX will move less than 1% as there is that it will move > 4 or 5%. Obviously, as Coach has stated, there are other factors at play. Still I often see many posts here where people espouse how volatility can decimate our credit spreads. I'm not sure that the data bears that out (it probably does if the VIX is > 30 to 35, but I'm not so sure about levels below that). Perhaps we can get a better perspective on how volatility is "likely" to affect us (again, there are other factors to consider).
Just wanted to check with you. You're aware that VIX changed a couple of years ago? Not sure if your historical data takes that into account.
Originally it was based on OEX options ATM IV but now it is based on a range of options series on the SPX. Can't remember the exact details.
RE: Your comments on VIX/SPX correlation, the old adage "When the VIX is high it's time to buy, when the VIX is low it's time to go" as a contrarian indicator for directional movement of the OEX/SPX has stood the test of time!
Momoney.
Originally it was based on OEX options ATM IV but now it is based on a range of options series on the SPX. Can't remember the exact details.
RE: Your comments on VIX/SPX correlation, the old adage "When the VIX is high it's time to buy, when the VIX is low it's time to go" as a contrarian indicator for directional movement of the OEX/SPX has stood the test of time!
Momoney.
No, I wasn't aware of that. Thanks for bringing that up.
I should mention that my initial comments on the graphing that I did are all predicated on the assumption that one's strategy is to trade fairly deep OTM credit spreads with the plan to hold to expiration (the typical retail trader who frequents this forum).
I should mention that my initial comments on the graphing that I did are all predicated on the assumption that one's strategy is to trade fairly deep OTM credit spreads with the plan to hold to expiration (the typical retail trader who frequents this forum).
Quote from momoneythansens:
Just wanted to check with you. You're aware that VIX changed a couple of years ago? Not sure if your historical data takes that into account.
Originally it was based on OEX options ATM IV but now it is based on a range of options series on the SPX. Can't remember the exact details.
RE: Your comments on VIX/SPX correlation, the old adage "When the VIX is high it's time to buy, when the VIX is low it's time to go" as a contrarian indicator for directional movement of the OEX/SPX has stood the test of time!
Momoney.
But just to be clear I never advocated that these spreads be held to expiration no matter what. That is what the adjustments are about. Holding to expiration allows for much greater losses. That is the main reason I avoid mechanical straightforward rules like that.
I know you had to make an assumption to do your testing but just wanted to make sure there was no confusion on the real approach to the strategy.
Phil
I know you had to make an assumption to do your testing but just wanted to make sure there was no confusion on the real approach to the strategy.
Phil
Well the basic goal is to let them run to expiration worthless but I am a little more active. If I can close out some of hte spreads for a significant profit I may do so and open more spreads at closer strikes depending on market conditions. I was able to do that a lot this summer for great returns. So I will trade them any way the market lets me do it! I also do this because I like to roll to the next month with new positions when I can.
I try not to lock myself in to a specific approach and go with the market flow. In general you can hold until expiration and open new posiiton the following week but sometimes I find opportunities to do this sooner or more often for more premium.
Phil
I try not to lock myself in to a specific approach and go with the market flow. In general you can hold until expiration and open new posiiton the following week but sometimes I find opportunities to do this sooner or more often for more premium.
Phil