SPX Credit Spread Trader

El OchoCinco · Dec 7, 2005

I actually always glance at the ATM straddle and try to make sure my strikes are well outside of that range at a minimum.

If I can translate riskarb's comment into our English (and risk arb feel free to correct me), is that the ATM straddle is being priced by the market maker on current IV estimates to cover the potential range of index moves from that point to expiration. If the index is at 1260 and the 1260 JAN straddle is at $40.00 then the MM are pricing based on an expected distribution of 1300 and 1220 of the prices to expiration. Since they want to price the straddle so that they are covered on buy or sales, you assume that their straddle pricing is a their good estimate of the market range they see as of that moment over the life of the straddle. This changes daily with volatility and index changes but gives you the range distribution.

Quote from riskarb:

You guys/gals should always be mindful of the atm straddle premium when choosing your strikes. The atm straddle is a pure-representation of the implied distribution to expiration.

riskarb · Dec 7, 2005

Quote from skdoyle1:

Ok, I'm really trying to understand what your talking about, I just think it's 3 levels over my head. So, the current ATM straddle for DEC on the SPX is:
SPX at 1257
Dec 1255 straddle 17.00x18.40
How does this help us?

Also, I don't understand why if you think the SPX will hold up would you short the SGX (yes, this is the first time I've heard of this) and the futures. I know your not a credit spread'er, and would like to learn what you are trying to do, I just think we're a little lost...
sd

Please refer to OC's less nebulous explanation ^^^ as it sums it up well.

I don't think the SPX will take out the highs, and went short the Nikkei on yesterday's SPX performance. It's a trade with a 7-day horizon. The SPX closed well below the value-area on Market Profile, and it's been pretty accurate recently with these range-expansion days. My SPX projection was bearish, but I don't think we take out 1236 as was mentioned by piccon. Simply IMO.

El OchoCinco · Dec 7, 2005

Still looking for some mini-bounce in the S&P overnight/pre-market/morning. I am not as bearish as I am neutral, i.e. lot of sideways movement over the next week or so. 1250/1270 with perhaps a dip to that 1245 level.

Quote from riskarb:

Please refer to OC's less nebulous explanation ^^^ as it sums it up well.

I don't think the SPX will take out the highs, and went short the Nikkei on yesterday's SPX performance. It's a trade with a 7-day horizon. The SPX closed well below the value-area on Market Profile, and it's been pretty accurate recently with these range-expansion days. My SPX projection was bearish, but I don't think we take out 1236 as was mentioned by piccon. Simply IMO.

momoneythansens · Dec 7, 2005

To be sure, to be sure, there's gold in them thar posts.

Distro = distribution.

It's generally accepted that IV of ATM options (CALLs and PUTs) are a good predictor of future volatility under the right circumstances. There are numerous papers written on this subject with varying conclusions on best time frames and CALLs vs PUTs etc. so I won't bore you with the details here.

Using the IV you can infer an Implied DISTRObution of future prices and therefore make your strike selection based on that if you are executing a FOTM strategy.

Not sure that all helps.

Momoney.

Quote from skdoyle1:

You must be the most patient man I've ever met. When I first read his posts, that he is trying to trade without actually understanding:
1) That he is selling puts naked without understanding margin (gasp!)
2) Doesn't understands what a credit spread is
3) I'm sure has no concept of the whole main point of this thread "RISK MANAGEMENT" (makes for a thin wallet)

I was experiencing what the bush administration calls, "Shock and Awe". But not you, you just write back the simple answers, and walk everyone through the steps, beginner, intermediate, or advanced.

Well I say, good job sir, for keeping everyone in the game and not losing it! That's why there are over 400 pages to read in this forum.

sd

PS: Can anyone explain to me what RiskArb is talking about?? I'm sure it's a valuable contribution, I just can never figure out what he is saying. For example what is distro??

chrdso · Dec 7, 2005

Quote from riskarb:

IOW, if the Jan straddle is 45 points, don't sell spreads within that 90 point range.

Thank you riskarb and (coach for explaining).

I usually sell > 1 std. deviation away. The ATM straddle cost is a great way of looking at the range of index movement (to expiration) based on current IV.

A formula for the estimated move (EM) of a stock or index:

EM = Stock price (SP) * Historic Volatility (HV) * Sq. root of days to expiration / Square Root of 252 (Trading days in a year)

if stock is at 100
HV = 40%
days to expr. = 2.5 . sq. root = 1.58

then,

EM = 100 * .40 * 1.58 / 15.875 = 3.98

So, the stock will trade within a range of 4.
68% (1 std. deviation) of the time

El OchoCinco · Dec 7, 2005

Basic approach is try to stay outside of that range and add more strikes if you do this. MM can be wrong and unexpected events can change things so do not try and hover on the fringes of the straddle ranges. For example with index at 1257 the 1260 JAN straddle is price at $39 at the ask with 43 days to expiration.

You want a clean cookie cutter approach? Start at 2x the straddle price when looking at strikes. It is always best to study the charts and look for resistance, support, blah blah when selecting strikes, but for quick back of the envelope study you can use this as a guide to find your starting points.

Quote from chrdso:

Thank you riskarb and (coach for explaining).

I usually sell > 1 std. deviation away. The ATM straddle cost is a great way of looking at the range of index movement (to expiration) based on current IV.

burrben · Dec 7, 2005

Cool I just got my first Xmas present. I'll always keep that in mind now. Jeez, I guess all you have to do is ask! Thanks all.

Now if I can just figure out why were trading on the Nikki.......

Quote from momoneythansens:

To be sure, to be sure, there's gold in them thar posts.

Using the IV you can infer an Implied DISTRObution of future prices and therefore make your strike selection based on that if you are executing a FOTM strategy.

Momoney.

riskarb · Dec 7, 2005

Quote from skdoyle1:

Cool I just got my first Xmas present. I'll always keep that in mind now. Jeez, I guess all you have to do is ask! Thanks all.

Now if I can just figure out why were trading on the Nikki.......

14% vol. Japan goes absolutely comatose around the holidays. Looking for a range contraction since I've essentially sold all the available gamma I could get my hands on. Think global index markets will trade a little lower as well.

I realize it's OT, but you asked.

Anyway, get back to the business at hand, sorry for the interruption.

burrben · Dec 7, 2005

Since I'm on a roll here, could you explain "sold all the available gamma"? What constitutes selling gamma, shorting?

sd

Quote from riskarb:

14% vol. Japan goes absolutely comatose around the holidays. Looking for a range contraction since I've essentially sold all the available gamma I could get my hands on. Think global index markets will trade a little lower as well.

I realize it's OT, but you asked. Anyway, get back to the business at hand, sorry for the interruption.

El OchoCinco · Dec 7, 2005

Japan market is usually dead around this time of year, except for that one January where Nick Leeson bankrupted Barings LOL. j/k

Quote from riskarb:

14% vol. Japan goes absolutely comatose around the holidays. Looking for a range contraction since I've essentially sold all the available gamma I could get my hands on. Think global index markets will trade a little lower as well.

I realize it's OT, but you asked. Anyway, get back to the business at hand, sorry for the interruption.