Statistical edge with option spreads -none?

asiaprop · May 16, 2009

buddy, despite the fact that you seem quite knowledgeable in trading options, let me tell you that you are dead wrong about this: I regularly scored dealer arb profits in the region of 1-3 vols (sometimes several times per week) all on Asian index options. I hear similar stories of a guy trading Eurostoxx50 index options. The are all listed, I agree, however, that visibility beyond the first 2 front months is next to nil in Asian listed index options. So if you mean that such mispricing would not occur if all expiries were listed and highly liquid then I would have to agree with you. If you are actively in the market then you may have witnessed some amazing holes in eurostoxx50 options last year when a huge insurer traded vol in incredibly huge size through DB in London. This sucked in all neighboring strikes and expiries as well not just one particular one.

I am not an exotics guy so I dont follow all of your below arguments. I sell expensive options, buy cheap ones, manage my risk around it. Of course I also take directional views, express views on implieds vs realized, views on skew, but thats not under discussion here. I believe following structured flow in this environment is useless, structured flow in Asia is all but dead, the times are long over when structured flow dictated skew, for instance. We may get there again but not any time soon.

I mentioned in my last post I dont want to go into further details, I am not the only one who depends and benefited from said models at our desk. One last comment though, have a look at skew spreads, for instance, the skew spread between kospi and hsi or kospi vs nky. Only a crazy person would have gone outright short skew last year in Sept/Oct., however, it paid trading some of the skew spreads. I have seen more sell-side guys blowing up because of excessive skew exposure than through delta or gamma.

Quote from atticus:

It really isn't possible in listed markets. Any persistence would take place in up or down&out strikes in which you would need to carry substantial gammas to realize any significant numbers. The best empirical evidence is the down&out skew in equity index markets. For one, I would love to see how to avoid gamma in an index skew trade. The surface would be traded flat if it were possible.

Flow impacts pricing that can result in, say, 300bps in skew on a near-atm strike in XYZ, but that's not really what we're talking about here, as you're referring to hedging vega, gamma, speed, and... You would refer to trading conversions, boxes and rolls. OTM gamma/vega is a good sale, but it's not enough compensation to maintain a static gamma position.

Dealer mispricing is the only instance in which I've witnessed persistence. Recently a pricing error on dealer-traded exotic calls traded with OTC and listed vanilla puts and spot to effect the reverse-conversion. It's a major bank and it's been evident for at least two months. This would never last in a transparent market. The dealer in question is only seeing the call side of the transaction and is known to limit hedging to deltas.

atticus · May 16, 2009

Quote from asiaprop:

I mentioned in my last post I dont want to go into further details, I am not the only one who depends and benefited from said models at our desk. One last comment though, have a look at skew spreads, for instance, the skew spread between kospi and hsi or kospi vs nky. Only a crazy person would have gone outright short skew last year in Sept/Oct., however, it paid trading some of the skew spreads. I have seen more sell-side guys blowing up because of excessive skew exposure than through delta or gamma.

Don't blow smoke with the replication BS, as you were talking Nikkei OR Kospi, not the replication.

Your anecdote of 1-3 in a dealer market isn't remotely the point, as the thread topic concerns listed vol markets. 2 on the vol-line in SPY equals the nickel-market on the ATM call. You're perilously close to losing that on your spot-hedge.

Here's a scenario that doesn't seem to want to be traded flat. Long the atm Euro binary call, short the listed atm put, short spot. The reversal earns 30bps, but requires the purchase of a fixed-strike 10-delta lookback call, as the binary call is a synthetic [binary-range] and is bounded. Netted it hits 18-20 at all points, and there is an outlier home-run potential on the lookback. An example od a persistent and large arb, not 1-3 points which is consumed by hedge risk.

asiaprop · May 17, 2009

sorry but what is the relevance of anything you said to the topic or my earlier post? Nobody denied that arb profits are possible in exotics (I hardly call lookbacks or binaries exotic but depends I guess from where you look at it).

I mentioned the dealer arb because you specifically asked me about it.

Quote from atticus:

Don't blow smoke with the replication BS, as you were talking Nikkei OR Kospi, not the replication.

Your anecdote of 1-3 in a dealer market isn't remotely the point, as the thread topic concerns listed vol markets. 2 on the vol-line in SPY equals the nickel-market on the ATM call. You're perilously close to losing that on your spot-hedge.

Here's a scenario that doesn't seem to want to be traded flat. Long the atm Euro binary call, short the listed atm put, short spot. The reversal earns 30bps, but requires the purchase of a fixed-strike 10-delta lookback call. The binary call is a synthetic [binary range] and therfore is bounded. Netted it hits 18-20 at all points, and there is an outlier home-run potential on the lookback. Traded from the buy-side.

atticus · May 17, 2009

Quote from asiaprop:

sorry but what is the relevance of anything you said to the topic or my earlier post? Nobody denied that arb profits are possible in exotics (I hardly call lookbacks or binaries exotic but depends I guess from where you look at it).

I mentioned the dealer arb because you specifically asked me about it.

I actually asked about a LISTED trade, hence the caps on the word "listed". I actually thought that part was abundantly clear. You answered with a replication trade... which may perhaps carry some correlation risk. So you trade the spot calendar, but that's not the point. The thread is talking single-asset arb.

I'll ask for a third time, in reference to your quote which I have pasted to the bottom of this post:

I asked you a question on page 9 of this thread -- what persistent LISTED vanilla vol-skew, in any market, have you been able to isolate at nominal gamma?

It's not a question of pure-arb. All I would like is an example that satisfies the following [your quote] in a listed-market:

On the other side with a working vol model it is indeed possible to persistently identify under or overvalued options. No need to take a directional bias, in fact I traded most of the time other options against such positions in order to mitigate any remaining vol, skew, or gamma exposure.

atticus · May 17, 2009

Quote from asiaprop:

(I hardly call lookbacks or binaries exotic but depends I guess from where you look at it).

The binary is traded synthetically. Shoot me a new definition as they sure aren't vanillas.

asiaprop · May 17, 2009

Sorry Atticus, but risking that my posts be considered lazy and dubious I also mentioned now several times that I will NOT go into further details. Which options I trade as a function of model output and how I manage the risk exposure is not something I plan to volunteer here. Gomen ne ;-)

Quote from atticus:

I actually asked about a LISTED trade, hence the caps on the word "listed". I actually thought that part was abundantly clear. You answered with a replication trade... which may perhaps carry some correlation risk. So you trade the spot calendar, but that's not the point. The thread is talking single-asset arb.

I'll ask for a third time, in reference to your quote which I have pasted to the bottom of this post:

I asked you a question on page 9 of this thread -- what persistent LISTED vanilla vol-skew, in any market, have you been able to isolate at nominal gamma?

It's not a question of pure-arb. All I would like is an example that satisfies the following [your quote] in a listed-market:

On the other side with a working vol model it is indeed possible to persistently identify under or overvalued options. No need to take a directional bias, in fact I traded most of the time other options against such positions in order to mitigate any remaining vol, skew, or gamma exposure.

atticus · May 17, 2009

Quote from asiaprop:

Sorry Atticus, but risking to be considered fuzzy in my explanations I mentioned also several times now that I will NOT go into further details. Which options I trade as a function of model output and how I manage the risk exposure is not something I plan to volunteer here. Gomen ne ;-)

Alright, well, about what I expected. The World needs dilettantes too. Seriously, thanks for your time.

asiaprop · May 17, 2009

nice teaser but thanks...not picking up on that.

By the way why won't you volunteer to expose to all of us your vol model and maybe you can describe to all of us why you think you have an edge in this market and where that edge exactly lies?

Quote from atticus:

Alright, well, about what I expected. The World needs dilettantes too. Seriously, thanks for your time.

panzerman · May 17, 2009

Consistently making money in options (or any other tradable vehicle) hinges on being right. That could be direction of the underlying, direction of IV, time, amount of order flow, direction of interest rates, or most likely, combinations of any of these or more.

So for the folks who say they don't make directional bets, that's disingenuous. You are still making a bet on the direction of something, and you have to be right more often than not in order to consistently make money. For me, I only sell options, and then, only to hedge. And yes, I still lose money sometimes on my hedges, beause I get the direction of the underlying wrong, and yes I'm a retail trader.

iloveoptions · May 17, 2009

Quote from panzerman:

Consistently making money in options (or any other tradable vehicle) hinges on being right. That could be direction of the underlying, direction of IV, time, amount of order flow, direction of interest rates, or most likely, combinations of any of these or more.

So for the folks who say they don't make directional bets, that's disingenuous. You are still making a bet on the direction of something, and you have to be right more often than not in order to consistently make money. For me, I only sell options, and then, only to hedge. And yes, I still lose money sometimes on my hedges, beause I get the direction of the underlying wrong, and yes I'm a retail trader.

You're absolutely positively correct. You're always making a bet on the greeks.

However, betting on the direction of the underlying through options (if your timing is good) yields the most profits and return on equity, so long as you're buying cheap IV that just started to reverse upwards. That will help you offset some of your theta. Couple that with quick thrusts in the underlying and you're in long gamma heaven. For example, on Friday, I entered KO January '10, 45 straddles, do you think I have an edge in that?