Trade management: adjustments

[BlueWaterSailor]

I was referring to the guy from TastyTool adding flies inside the condor. It's not a hedge. He's adding risk. OK, so he can reduce the local delta pos, but he loses double outside the wings. I don't want to quibble about the actual PNL.

Long wing-spreads act as synthetic long puts and calls when traded with the underlying. Say you're trading XYZ and long the DOTM strangle. Long XYZ and the put = synthetic long call. Short XYZ and the call = synthetic long put. Or you're trading defined-risk as a futures trader with the long strangle. ATM condors (flies) are typically 1:1 risk so you're swapping risk for terminal performance, i.e., The prob of expiring outside the wings of the strangle may be 10%, but the risk may be 10:1 against.

And yeah, I am referring to the strangle and not the IC, but the principle is the same. The condor is simply there to define the risk.

I sell wing-spreads all the time, but against the underlying.

Damn. I actually got almost all of that. I must be getting smarter from associating with you folks.

So... OK, he's reshaping his original risk profile to reduce the local delta position, and paying for it in increased risk elsewhere (and the overall risk increases because, well, ain't no free lunch.) I can only assume that you're saying it's mega-stupid because the increase in risk he's taking on is disproportionate - which presumes that there's a smarter way to do this. I may be mistaken, but it looks like you're saying hedging is it.

I'm still quite clumsy with synthetics, although I have the basic idea down; no "natural feel" yet for how to use them. That's likely a large part of my problem in understanding/visualizing adjustments. But I can see applications to hedging from what you're saying there: if I have a call that's being tested, I can convert it to a synthetic put by shorting stock. ...OK, I'll have to burn some midnight oil; I need to see the effect of this to really nail it down. What will price movement do to this trade if I short enough to zero the delta? What about 10% more, or less? Grrr. Wish I could visualize this stuff already.

And sure, I'm familiar with the risk/reward tradeoff; 10% ProbITM implies an inverse risk ratio (although, just off the top of my head, I seem to recall a roll-off as you go further OTM; i.e., you pay for the "safety" of being FOTM.) The best RRR is still ATM, or somewhere close to it - but this seems like it would require the ability to make directional predictions. Lots of questions in my mind about wings - tail risk vs. return vs. stops vs. hedging - but that's a different topic.

(Perhaps this is a bit of craziness on my part, but in my Copious Spare Time, I'm slowly starting to build an ML system where I can run different models and test my assumptions. One of my former employers gives me access to a distributed system environment with DS/ML tools, and I'm pretty good with the relevant Spark/Scala/Python tooling on it - used to teach the stuff. 'Cause, you know, I don't have enough to do, and too many free hours in the day.)

By the way: I've read quite a number of your threads/journals here on ET, and have been absorbing whatever my current (expanding, but too damn slowly) capacity permits. It's been one of the most effective increments to my education about options - I've stared holes in my screen looking at your trades and trying to understand everything I can about them - so I'm quite grateful. If we ever run across each other somewhere, the beers are on me as long as your kidneys hold out.

 

[destriero]

Long wing-spreads act as synthetic long puts and calls when traded with the underlying.

Long wings (strangles); not wing-spreads.

 

[BlueWaterSailor]

Long wings (strangles); not wing-spreads.

That took an uncomfortably long number of seconds before I got it.

Check, the wings are a long strangle. As soon as I subtract the (narrower) short strangle from the IC, that is - of course, duh - what it becomes. It had become cemented in my brain as two verticals, but that's just one way of seeing it.

That actually moved the needle significantly on clarifying the whole adjustment picture. OK... practice with synthetics and trade decomposition scheduled.

 

[Wheezooo]

I believe one of tenants OptionsAlpha teaches is to only adjust the profitatable leg - never the loosing one. Isn't it increasing your risk in a losing trade? Kind of like averaging down? What do you guys think about this particular rule?

Despise it. Really,really,really despise it. Always start from the perspective of 0. Every second forward, and what is behind should remain there. Whether you are up or down on a trade should never influence your action. Do you like it now is all that is relevant.

Besides why do I care about individual legs? I care only about the entire surface of my book. (s/b past tense)

 

[Wheezooo]

"locks in your loss"

I'd advise you begin removing phrases such as this from your vernacular. Try to think from a MTM perspective. You took the damn loss already!!!!

 

[BlueWaterSailor]

"locks in your loss"

I'd advise you begin removing phrases such as this from your vernacular. Try to think from a MTM perspective. You took the damn loss already!!!!

Interesting. So, as the price moves, you're continuously either taking losses or making gains, despite not having booked either one? That seems rather extreme.

I understand the useful side of this perspective, just as I understand the useful side of expecting reversion during the remaining period to expiration. I'd appreciate it if you could elucidate why you think the former is preferable to the latter, in such an absolute manner.

 

[Wheezooo]

price, vol, time... Yes. That gain or loss was reflected in my daily net liq. Always felt booked to me.

I never expect reversion during the remaining period to expiration. That is an EXTREMELY dangerous assumption. I highly suggest that if you are going to make assumptions, you begin by assuming the exact opposite.

 

[BlueWaterSailor]

price, vol, time... Yes. That gain or loss was reflected in my daily net liq. Always felt booked to me.

I never expect reversion during the remaining period to expiration. That is an EXTREMELY dangerous assumption. I highly suggest that if you are going to make assumptions, you begin by assuming the exact opposite.

Doing my best to track with you, but... not assuming reversion cuts the ground from under all credit trades, where selling at high IV and expecting vol reversion is the foundation. So, either your basis for trading is different from everything I know, or I'm not getting your point.

 

[Wheezooo]

"not assuming reversion cuts the ground from under all credit trades, where selling at high IV and expecting vol reversion is the foundation"

Wouldn't that cut the ground from under all debit trades, where if it were correct to 'assume' vol reversion, buying at high IV makes that person a moron? So why does a market maker, infinitely more knowledgeable than you, willingly and with indifference, provide you a bid?

 

[BlueWaterSailor]

"not assuming reversion cuts the ground from under all credit trades, where selling at high IV and expecting vol reversion is the foundation"

Wouldn't that cut the ground from under all debit trades, where if it were correct to 'assume' vol reversion, buying at high IV makes that person a moron? So why does a market maker, infinitely more knowledgeable than you, willingly and with indifference, provide you a bid?

@Wheezooo, it may be that we can't communicate at all; you have the habit of swinging for the fences and making absolute statements in places where they seem unwarranted. You also seem to get instantly offended when anything you say is questioned. I'm actually trying to understand what you're saying and assuming good intent, but that assumption is starting to break down.

My take on someone making a debit trade at high IV is not that they're a moron; for now, I don't know enough to assume anything of the sort - it may be that they have some (actually successful) strategy that I'm not aware of, and I'd treat it as another opportunity to learn. You know - kinda like me asking you about your possibly different basis for trading? It's not a trade that I would make right now, knowing what I know so far; to me, debit trades are what you do when IV is low. But I remain open to being corrected.

As to cutting the ground from under debit trades - that's not a sensible counter-argument because the two are not mutually exclusive. The MM reference is also not particularly cogent, since the answer is "because the MM wants to make that B/A spread." They're not doing it for my pleasure, or because they're a disinterested party - and their interest is usually contrary to mine.

If you want to explain why I'm wrong, please feel free. But continuing to tell me how absolutely wrong I am, in absolutely all circumstances, with absolutely zero useful explanation of how to correct it, and what the basis (other than my frankly admitted ignorance) is, is absolutely useless.