SPX Credit Spread Trader

IV has hit it on the head... again. I have read/heard this comment from at least a half dozen proficient traders (Dr. Z's posts on another thread, guys at TOS, others...).

You have to catch the period in time where the average true range (easily available in most charting software) is shrinking but the vol is still high and has not caught up with the "quieter" market. On the flipside, if you put on a credit spread now (for say 1.00 credit) with VIX near an all-time-low of 10 (VIX usually sits between 10 and 30) and VIX starts to climb and the index gets close to the short strike, it won't be $2.50 to get out like it is now... it'll be very painful.



Quote from IV_Trader:

here is my final take on this strategy : its worked in FALLING iv/vols environment when price action was lagging the vols ( Vix at 30 , but price moved only 2.5% then vix at 25 but price moved only 2% , etc,etc). While we are at the lowest 10 percentile for VIX , one should ask himself how the strategy will perform if VIX will start to rise from here.
Unless you are a very good directional trader.
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rdemyan,

Unfortunately, I can't give an example trade just yet -- need a few more days to work through this. But just take your current Jan spread and model it with a Day 1 hedge and put and call calendars to get overall positive vega, and see what your position does when the SPX moves and go from there.

The super-traders on this and other threads (riskarb, Dr. Zhivodka,...) who have been doing spreads for 15+ years have provided enough hints (which I've confirmed with the guys at TOS) for us to get this right.

I no longer believe you can just put on a spread, wait till the going gets tough and then put on a hedge, then roll when the going gets really tough and hope for the best, and finally take the spread off at the last minute if/when you reach hell's doorstep. And if VIX has popped, you're dead. Can you imagine say, a $100M fund with this strategy? (Check out Max Ansbacher's fund). I can't. No offense to anyone on this thread (especially Coach for being a wonderful leader) but I think we all need to get a little more sophisticated.

Perhaps the most important hint from the experts is that with VIX at an all time low, this may not be the right time to sell premium, but a good time to buy premium.... or even if you choose to sell premium, at least get your overal position vega back month positive. We're all learning here (including Coach) and I hope folks listen to the experts when they give us hints and try and follow through (at least that's what I'm trying to do).


Quote from rdemyan:

Andy:

Can you provide an example trade of this alternate risk management strategy?

Thanks.
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I've attached a weekly chart of SPX, VIX, and some ATR indicators.

The top chart is the SPX since 1980.

The second chart is the smoothed (using a 40-week moving average) Average True Range -- ATR(10). If folks are unfamiliar with ATR please google it but it's basically an average of how much the underlying moves each day.

The third chart is the smoothed ATR/Close. This tells us how much SPX moves daily as a percentage of it's closing price -- an indicator of "quietness versus movement/bounce".

The fourth chart is the smoothed VIX truncated because the data goes back to 1990 whereas the SPX chart goes back to 1980.

Circles A, B, C, D and E are times when the SPX was getting quieter each day, while vol (ie. VIX) was high -- and although VIX was declining, it was possibly declining such that a spread could be put on with super credit vis a vis the "movement" of the SPX. Now D and E are perhaps not as good as A, B and C because the VIX is falling at such a fast rate. These five periods in time were probably the best times for credit spreads. Also look how directionally smooth (hard to see on this chart) and trending the market was in A, B and C.

Now look at the right hand edge of the chart. Looks like 1994 where the bounce of SPX as well as the VIX are near all time lows. I have not done credit spreads in a 1994-like market and I'd bet it's quite different from the current market. Some input from an experienced trader who lived through a rising vol market would be great, but I'd bet it's nasty as the vol increases, but is lead by the bounciness of the SPX.

In other words, your credit spread premium is not keeping us with the stock's movement.
 

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Andy, I know several traders that use the VIX and the VXO simply as contrarian sentiment indicators. Put some Bollenger bands on the vxo for example, and when this indicator is low and giving several hits on the lower Bollenger band, 2 STD, it may well be time to get bearish. Once this occurs , even though premium may be skimpy, you can make money selling bear call spreads, and or buying puts. Its the reverse when the upper Bollenger band takes a number of hits. Compare a chart of the VXO, and one of the OEX, and see how many times this occurs. Obviously we always like fat premium, but the strategy will still be applicable. I cant wait for this low VIX to turn around and for this market to fall out of bed, so that I can short the crap out of it. Meanwhile , I have been making nice profits every morning in this rising market , just buying calls. Taking them off for the most part by noon and going home flat with money in my pocket. You can make this real complicated if you want, or you can find something you can work with, taylor it to your own risk tolerances, and go with it like Phil does. Just dont be a follower, come up with your own thing and go with it. Not all credit spread traders trade Irons and then adjust, and for that matter, neither does Phil.
 
But how do you define trend?

If it's subjective, you'll be second guessing yourself every time.

One of Coach's techniques is to sell into premium, that means taking positions against the trend.

Quote from andysmith:

Dr. Z,

I think the number of adjustments can be substantially reduced if a couple of ENTRY rules are followed (my two cents here based on what I have learned):

1) If the market is trending strongly when the spread is initiated, put on a spread that follows the trend.

2) Don't put on a spread against the trend hoping the trend will peter out before expiration... and before the short strike is hit (the folly this month). (In other words, don't call tops and bottoms).

3) Put on a spread each month but resist the urge to do an iron condor each month. Do it only if the market is going sideways.

4) Put on a hedge at the same time the spread is initiated. Look at it as insurance or a tax to play the game. Don't wait till you need the hedge -- it might be too late.

5) Watch position size.

There are also EXIT rules but the ENTRY rules above, at least in my case, will cause fewer adjustments.
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Quote from dottom:

But how do you define trend?

If it's subjective, you'll be second guessing yourself every time.

One of Coach's techniques is to sell into premium, that means taking positions against the trend.
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To simple sell into strength randomly is not only irresponsible but stupid.


Every trend will have a definable END to it and one just needs to study past ENDS to make the correct recognition.


Trust me I learned this one the hard way too many times.

My advise is to ALWAYS wait for the trend to STOP first and that can be achieved by going through historical examples and looking for the commonalities.
 
Andy , some time ago I wrote a simple formula to calculated ATM combo premium when historical data is not available.

X=ATM combo premium= (XYZ * VOLS * 2.268)/1000
where time=30 days
XYZ=price of stock at the beginning of the month (which also used as a strike)
Sample : Starting price=42 , Vols =14 , then 42 straddle premium=1.33(on the ask)
Store ABS monthly % change of XYZ into Y.
Now you can compare average of X to average Y and assign the over/under value "labels".
obviously any back testing process needs more work , but a use of this formula will get you to the fast start.
PS : don't be surprised to find out that in many cases Ave X will be equal to Ave Y ; this is just another confirmation of "no free lunch" or "perfect option's pricing" theories.
 
What I am learning is that when you do an IC rather than FOTM put spread you will naturally sweat....either up or down. I don't think it is easy and I don't believe Phil ever took the position that it was. His thesis (my understanding...that is) is if you do FOTM credit spreads for small change the odds are that you will not have to do much adjusting and I agree. For myself I choose to play closer to the vest but am willing to "sweat" it out and make adjustments. We all agree there is NO free ride in the market. You either must take directional risk or volatility risk to make money. IMHO
Quote from Dr. Zhivodka:

After actually participating in market action, rather than simply reading about it, does anyone here still believe that this strategy requires only 1 or 2 "adjustments" per year?

This thought was offered several hundred pages ago in this thread. It was a thought of which I tried to disabuse from the minds of the loyal participants of this thread.....to little avail.

Of course, I have traded this way for years and years (among several other styles). I found years ago that is not quite as easy as it first appears....though it can be very profitable over time if done right and with a sufficient bankroll.

I wonder what the preponderance of thought is now among those who've been in the fight?

Best,
Dr. Z
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Phil is a co-author and I have read the book. A large part of the book is devoted to using options in conjunction with stocks which I found very useful. However probably not as much usage of adjustments in more complicated spreads, which many people looking at this thread may be expecting. There is a fair amount of spread strategies in making adjustments which can lock in profits etc and sometimes to minimize loss. It is well written and useful... there is no self-promotion or selling something else, which I thought Fontanills "Volatility Course" did ad- nausieum (sp?)...let me put it this way. I'll be happy to sell you at half (my)price my copy of "Volatility Course"..but I'm keeping "The Option Trader Handbook" :D

Quote from Samson77:

Has anyone here bought Phil's book?

I'm looking for an unbiased review of it!
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Just to clarify, the adjustments are not the way I am making money. Adjustments are what I am forced to make in certain market conditions and I try and avoid them if I can. Just to remind people that I adjust when I have to but I have also said that sometimes the best move is to close the spread and just get out of the way of the market. One or two people have simply closed spreads this month and there is nothing wrong with making tha tmove and then looking to the next month. One reason I am holding on here is because I feel we have gotten ahead of ourselves and if we have any real pullback I may very well simply close the calls outright. With 3 full weeks to expiration it is a different scenario than if we have 1 week left- theta is quite different.

As for those exploring other means of applying this strategy, this journal was not meant to be a fixed narrow discussion. I wanted the journal to flesh out ideas and approaches and refinements. I am constantly experimenting on paper with ways of refining my strategy and improving partial hedges. That is why when people criticize the strategy I always tell them to give us something to go with that criticism to make it worthwhile. So do not hesitate to discuss and explore alternatives here.

With respect to IV, this JOURNAL has gotten quite long and I know some stuff gets buried. Some of you may remember my detailed posting where using a Black-Scholes formula I showed the effects of index moves and volatility changes on the spreads and the greeks of the spreads. AS that post showed, the greatest threat to your spread is delta/gamma. When I jumped the index input and increased IV, the huge change in the price of the spread came from delta/gamma while a much smaller change came from vega. That is the nature and partial hedge of doing a spread since the long option helps to partially offset the short option. Since delta can grow fast, that is what impacts the price of your spread while IV chnages and holding the index constant accounted only for small changes. Not to say you should ignore IV but never forget where the big risk lies- delta. IV rising puts a cherry on the riks sundae but never never forget that delta risk.

Also to clarify someone commented that I am selling premium into the trend or against the trend. Remember I said I would prefer to sell puts on down days or calls on up days to get better fills. My call or put spread decisions are still based on my overall analysis of the market. So if my analysis is giving me certain strikes for put spread sells, I made the decision to do so before simply looking for a down day. Do not confuse a down day with a selling put spreads in a clear downtrend or sharp collapse. A 4 point move lower is a down day and does not mean I am looking to sell puts in a market collapse. Also, in 30 days it is quite easy to get a good up or down day no matter the overall trend. If my analysis determines certain puts are a good entry then a down day will not change that unless the market really starts cooking and dropping lower. For those who follow closely, I have sold boughts on up days and calls on down days when I wanted to get in my strikes and establish my positions. I prefer getting in on days the market is leaning my way for better fills but I get in no matter what when the time and strikes are right. So I hope no one exaggerates that to imply I am looking for a market collapse to sell puts and a market surge to sell calls.

Anyway, some great discussions here so keep it going, both negative and positive. This journal is no longer about my trades an dhas not been for a long time. This journal is about trading a certain strategy and ways to improve your skill and trading performance, all under the umbrella of risk management. My skin is thick as long as the attack is not on me since I have not done anything to warrant personal attacks. I learn as I earn and the day I stop learnin' is the day I stop earnin'

Quote from IV_Trader:

Coach seems like a nice guy and I really belive that he want to help new traders. But I think his strategy making money because he is good/very good directional trader and NOT because of the ways he "adjust" positions when trade goes bad. THERE
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