The skew part II

[sugar]

Quote from dmo:

My point is that this would work IF there was no skew, IF every strike traded at the same IV.

My point is that this works, and works pretty good.

If market droops your positive vega-gamma will obtein money for you. If market rise your vega become negative, IV droops and you win too.

Your risk here is the volatility evolution when market goes back, you have not close your position and volatility don't regain its original value.

Then you'll lose money, but this is the game here, isn't it?

Regards

 

[dmo]

Quote from sugar:

My point is that this works, and works pretty good.

If market droops your positive vega-gamma will obtein money for you. If market rise your vega become negative, IV droops and you win too.

Your risk here is the volatility evolution when market goes back, you have not close your position and volatility don't regain its original value.

Then you'll lose money, but this is the game here, isn't it?

Regards

One more risk sugar - your thetas on your long puts are greater than the thetas on your short calls, since you paid a higher IV for the puts than you got for the calls.

 

[sugar]

Quote from dmo:

One more risk sugar - your thetas on your long puts are greater than the thetas on your short calls, since you paid a higher IV for the puts than you got for the calls.

Think about it like a vega-scalping strategy.

Remember that skew only affect your position if your put/call volatility spread changes. It really happens but is less important that volatility evolution. You bet.

Regards

 

[BeatingtheSP500]

Quote from dmo:

No no, gamma scalping is different. It's when you're long gammas and delta neutral - so every time the underlying moves the delta moves in your favor. Every time you even up your deltas, you're locking in a profit.

I posted an article explaining gamma scalping about a month ago - did you see it? There was a whole thread on the topic not long ago.

Just out of curiosity, is there a term to describe the other side of the "scalping gamma" trade?

 

[dmo]

Quote from BeatingtheSP500:

Just out of curiosity, is there a term to describe the other side of the "scalping gamma" trade?

The other side? You mean if you start out delta neutral and short gammas?

I would just call that being short premium. In that case you'd want to lose the scalping bit, because negative gammas means every time the underlying moves your deltas move against you and you lose money. So every time you even up your gammas you're locking in a loss.

 

[c.chugani]

Quote from dmo:

I promised in another thread to post what in my opinion is the number 1 most direct and precise factor driving the skew in S&P500 options. Here it is.

If I could buy OTM puts and sell OTM calls at the same volatility, I would make money day in and day out, virtually risk-free, with a ferocity and consistency the world has never known. I would quickly become the richest man in Babylon. I would be so rich I would fly all of you to Chicago and buy you a drink - even beep1 if he promises to behave himself.

How would I do that? I've mentioned before that when the S&P rises, the VIX drops and when the S&P drops, the VIX rises. That is true in every time frame - tick by tick, minute by minute, hour by hour, day by day. I've posted charts proving that point before, and would be happy to do so again. It's the most consistent phenomenon in all of trading - at least I can't think of a more consistent one.

So if the futures were 1200 and I could buy 1100 puts at say 20% volatility and sell 1300 calls at 20% volatility - and buy futures so I'm delta-neutral - It would be almost impossible to lose money. When the futures go up, I would become short vegas. What do you want to happen when you're short vegas? You want it to go down, and that's what would happen. Money in my pocket. I would buy premium cheap and become premium neutral again. If futures went up more, I would again become short premium (including short vegas) and volatility would drop further. More money in the dmo account. I would again buy premium and become premium neutral.

If futures went down, I would become long premium and volatility would go up. Still more dough in my pocket. I would sell the expensive premium until I was again premium neutral and await the next move, which again would only make me money.

And if ever there was a crash? My god - I would become so rich that Rupert Murdoch would become suicidal with jealousy.

But Mr. Market just hates when that happens. He can't stand it when making money becomes easy. So he prices the otm puts just high enough and the otm calls just low enough that it neutralizes the profits you would make from this play.

dmo,

Let me try to understand and conceptualize where you are coming from. By deduction, the reverse of your example should also hold true:

Assuming flat volatility curve (say 20% as per your example) for both calls and puts then - I could short puts, buy calls and short the underlying to remain delta neutral.

Could you provide a simple numerical example of how the above would also produce consistent profits? (given the hypothetical situation where the volatility curve remained flat)

Best,
Chirag

 

[dmo]

Quote from c.chugani:

dmo,

Let me try to understand and conceptualize where you are coming from. By deduction, the reverse of your example should also hold true:

Assuming flat volatility curve (say 20% as per your example) for both calls and puts then - I could short puts, buy calls and short the underlying to remain delta neutral.

Could you provide a simple numerical example of how the above would also produce consistent profits? (given the hypothetical situation where the volatility curve remained flat)

Best,
Chirag

You're forgetting the most important element of the whole play Chirag - the relationship between the underlying and IV. This would work in the S&P options ONLY because every time the S&P goes up, IV goes down, and vice versa.

So yes, if you found a contract with the opposite relationship (when underlying goes up IV goes up and vice versa) and you could buy OTM calls and sell OTM puts at the same volatility, this play would work.

 

[blackjack007]

Quote from dmo:

How would I do that? I've mentioned before that when the S&P rises, the VIX drops and when the S&P drops, the VIX rises. That is true in every time frame - tick by tick, minute by minute, hour by hour, day by day. I've posted charts proving that point before, and would be happy to do so again. It's the most consistent phenomenon in all of trading - at least I can't think of a more consistent one.

both spx and vix are up now as we speak. spx up 0.4% and vix up 3.7%. i've seen this happen many times. their relationship isn't as consistent as you claim.

 

[dmo]

Quote from blackjack007:

both spx and vix are up now as we speak. spx up 0.4% and vix up 3.7%. i've seen this happen many times. their relationship isn't as consistent as you claim.

I'm attaching a one-minute chart of the SPX vs the VIX from today's open until this minute. Ignore the opening VIX bar, which is a data glitch.

If this is the best example anyone can come up with to disprove the tight inverse relationship between the SPX and the VIX, then I rest my case.

 

[MasterAtWork]

Quote from dmo:

Actually, once you have this play set up (long the 1100 puts, short the 1300 calls, delta neutral against the futures), you can play it with futures alone. No need to touch the options position. That makes it really simple.

Each time the futures go up, volatility goes down, and you will get long deltas. Try it and you will see that's true. The more volatility goes down, the more money you will make and the more long deltas you will be.

You sell futures to get delta neutral again and lock in your profit. If futures go up more, IV will go down again, and again you will have a profit and be long deltas. You sell futures again to even up your deltas and lock in your profit. If futures then drop, IV will go up and you will get short deltas. You buy futures to even up your deltas and again lock in your profits.

This is easy to verify - try it for yourself. Keep in mind that the put and call volatilies remain equal - when the put goes from 20% to 21%, the call does too. That's the point of the exercise - to show how easy it would be to make money if the skew was flat.

I apologize for being so late to thank you for the example Dmo, since I was one who asked for. It wouldn't be polite, so thank you for your work and for your time.

BTW, you wrote "you sell futures to get delta neutral..." with which delta from which volatility, how long you do it (since futures have low transaction costs)? It could be interesting to see how you do it with skew. Some modifications, variations.