Trade management: adjustments

[kj5159]

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.

This is not necessarily true, you can make a trade such as a vertical credit spread where you're primarily interested in the price of the underlying more than vol. Sure, if you write a 65/70 call credit spread on XYZ when the underlying is at $50, you don't care about vol or IV so much (after placing the trade) as you do spot. You can have a marked to market loss if there is a big vol spike and the $70 call's value increases but as long as the $65 stays OTM it doesn't hurt you (assuming you hold the spread to expiry).

You can definitely sell vol to sell vol, but you can sell options for other setups too. A covered call is not necessarily a short vol setup, it certainly could be if that's the reason you want to sell the call, but it could also be just to collect premium basedon your opinion of the underlying and/or your other position(s).

Destriero is definitely the guy to talk to about synthetics.

Also try to think about (along the lines of what he was saying) which spreads are already in or partly in a different spread. So for instance an iron condor (for a credit) is a short straddle inside a long straddle, an iron butterfly is a strangle and a straddle, a regular butterfly is a credit spread and a debit spread etc.

Then think about creating a traditional spread with a synthetic component if you want to, so say you have a vertical spread with a synthetic long put (buy a call and short the underlying) and a natural short put to create a spread.

 

[BlueWaterSailor]

This is not necessarily true, you can make a trade such as a vertical credit spread where you're primarily interested in the price of the underlying more than vol. Sure, if you write a 65/70 call credit spread on XYZ when the underlying is at $50, you don't care about vol or IV so much (after placing the trade) as you do spot. You can have a marked to market loss if there is a big vol spike and the $70 call's value increases but as long as the $65 stays OTM it doesn't hurt you (assuming you hold the spread to expiry).

I've been told that big bad gamma and vega are waiting around the corner to mug me if I hold till expiration. Seriously, though - I don't know how useful an MTM approach is for me, given that I'm making small trades and not using leverage until I'm totally comfortable with all the basics. It's a reasonable perspective for large-scale traders swinging big margin and with lots of trades on, but for me, the end result (primarily, learning - but profit is nice too) is what really matters - and that's up in the air until the trade is over. Although individual trade value is, of course, useful as a decision factor.

As to vol not mattering in a spread... I believe I've seen a number of folks here talking about how vol will hammer the living hell out of you when you're short in a market moving against you - and given the fact of vol skew, I agree with them. Of course this requires that the short leg of the spread is ITM, but nobody really cares about successful trades when discussing risk - so we're sorta constrained to the ones where things have gone sideways.

I take your point about spreads being mostly neutral WRT greeks in general, though.

You can definitely sell vol to sell vol, but you can sell options for other setups too. A covered call is not necessarily a short vol setup, it certainly could be if that's the reason you want to sell the call, but it could also be just to collect premium basedon your opinion of the underlying and/or your other position(s).

Interesting; thanks for that - it's good food for thought. You can, of course, have a variety of theses which you then express via your trades, but I'll have to think more about the practical applications. The major theme I see is a reinforcement of one of my concepts: I must learn and become comfortable with all the major strategies used in options and other asset classes... or I'll be constrained to nothing but baby talk when trying to express my views (which is the case now.)

Destriero is definitely the guy to talk to about synthetics.

Also try to think about (along the lines of what he was saying) which spreads are already in or partly in a different spread. So for instance an iron condor (for a credit) is a short straddle inside a long straddle, an iron butterfly is a strangle and a straddle, a regular butterfly is a credit spread and a debit spread etc.

Then think about creating a traditional spread with a synthetic component if you want to, so say you have a vertical spread with a synthetic long put (buy a call and short the underlying) and a natural short put to create a spread.

I'm taking what @destriero says very seriously, and have been putting time and effort into understanding it (and yeah, synthetics are pretty cool. Wish I already knew about futures, though.) I'm also starting to see other strats as being composed of simpler structures, but haven't yet reached a point where I'm easy with visualizing what happens when you change something or flip to a synthetic version - but I'm already seeing that this is where the answer to my original question lies.

I'll also note that digging that deep can be intensely frustrating. I've come to realize that I actually don't (immediately) see how the addition of a long or a short/ITM or OTM/above or below affects a given structure. Argh, I thought I got that stuff at the beginning! Back to grade school. Dammit.

Thanks very much for your response.

 

[kj5159]

I've been told that big bad gamma and vega are waiting around the corner to mug me if I hold till expiration. Seriously, though - I don't know how useful an MTM approach is for me, given that I'm making small trades and not using leverage until I'm totally comfortable with all the basics. It's a reasonable perspective for large-scale traders swinging big margin and with lots of trades on, but for me, the end result (primarily, learning - but profit is nice too) is what really matters - and that's up in the air until the trade is over. Although individual trade value is, of course, useful as a decision factor.

As to vol not mattering in a spread... I believe I've seen a number of folks here talking about how vol will hammer the living hell out of you when you're short in a market moving against you - and given the fact of vol skew, I agree with them. Of course this requires that the short leg of the spread is ITM, but nobody really cares about successful trades when discussing risk - so we're sorta constrained to the ones where things have gone sideways.

I take your point about spreads being mostly neutral WRT greeks in general, though.



Interesting; thanks for that - it's good food for thought. You can, of course, have a variety of theses which you then express via your trades, but I'll have to think more about the practical applications. The major theme I see is a reinforcement of one of my concepts: I must learn and become comfortable with all the major strategies used in options and other asset classes... or I'll be constrained to nothing but baby talk when trying to express my views (which is the case now.)



I'm taking what @destriero says very seriously, and have been putting time and effort into understanding it (and yeah, synthetics are pretty cool. Wish I already knew about futures, though.) I'm also starting to see other strats as being composed of simpler structures, but haven't yet reached a point where I'm easy with visualizing what happens when you change something or flip to a synthetic version - but I'm already seeing that this is where the answer to my original question lies.

I'll also note that digging that deep can be intensely frustrating. I've come to realize that I actually don't (immediately) see how the addition of a long or a short/ITM or OTM/above or below affects a given structure. Argh, I thought I got that stuff at the beginning! Back to grade school. Dammit.

Thanks very much for your response.

Glad I can help. I'm not a pro by any means but I have picked up some useful nuggets thus far.

I would say as a study tool (this is the way my brain works, not sure about your personal learning style so feel free to take the gist of this and tweak it to teach yourself easier), go on your broker platform and if you have some kind of order entry screen where you can put in an order for a spread (i.e. you can just put in an order for a vertical spread without having to manually sell one option and buy another) and write down the name of every spread that is listed there on paper and break down each spread by its components, i.e. a vertical spread is long one option short one option same strike and expiry, then write down all possible synthetic ways to make that spread (with both puts and calls) and any spreads embedded in that spread (like an IC being two straddles) and how to make those embedded spreads synthetically.

Also look at what the main goal of each type of spread is in regards to Greek exposure (so a vertical credit spread you're just betting on spot price ultimately, while a 121 butterfly is usually a combination of price staying within a range and being short vol). Look at whatever the biggest Greek value of the spread is (or the two biggest I'd they're relatively close) and that will tell you what you'd mainly be betting on (Delta is biggest, betting on spot mostly, Vega is biggest, betting on vol etc.). Another way to view is to look at if you're putting the trade on for a credit (use a vertical credit spread again), look at which options provide the most credit/debit in the spread (in the case of a vertical credit spread it would be the nearer to the money short strike, for instance) to help with viewing how different moves impact the P&L of the overall position.

Just break everything down to it's smallest form and then view that and it's opposite and all of their effects, in essence.

Edit - Investopedia is your friend, great info on there in regards to defining and explaining terms (including synthetic relationships).

 

[drmark27]

Sure. I'd like to get more skillful at options-related adjustments - knowing which ones make sense in what situation, and understanding their pros and cons - but can't find any material beyond the basic "for ICs, roll the untested side; for singles, roll them out" advice.

There are at least <choose a large number> possible adjustments for any position you're ever in. They all have pros and cons rather than being definitively right or wrong. Some will be a better fit for your personal style, and hopefully that is what your trading approach will develop into.

If you want to become more skillful, then I'd suggest focusing on the different potential adjustments and understanding their pros and cons. Backtesting is then about seeing how those approaches work over a large sample size of trades, which can be very useful education. Beware of the potential pitfalls with the backtesting process, though, as results can sometimes be artificially distorted toward profitability.

 

[ironchef]

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.

This is very helpful. Thanks.

 

[BlueWaterSailor]

If you want to become more skillful, then I'd suggest focusing on the different potential adjustments and understanding their pros and cons.

That's pretty much a direct restatement of what I'm looking for. First, I need to find out what the different potential adjustments for various strategies are, and I'm working on that via the previous suggestions here; then, I need to understand their pros and cons, which I suspect will become more obvious as I get closer to completing step 1.

I'm not sure that backtesting is all that feasible on anything beyond simple strategies - and I just don't see how adjustments would play into that at all. If you have any practical suggestions for any of the above, I'd be glad to learn what they are.

 

[ffs1001]

...and write down the name of every spread that is listed there on paper and break down each spread by its components, i.e. a vertical spread is long one option short one option same strike and expiry, then write down all possible synthetic ways to make that spread (with both puts and calls)

@kj5159 , pls help me with this part. Lets say I have sold a put credit spread on the SPX at 2800-2775.
So, my long put (at 2775) = short SPX stock + a long call;
my short put (at 2800) = long SPX stock + a short call.

Okay, so far so good. Now, where do we go from here?
And how can I use this information to help with adjustments?

Regards

 

[MACD]

As to the above statement, I don't think you'll find a set of heuristics that meet your needs until you've narrowed down what you're trying to accomplish (managing a perpetual book in a single underlying, or placing frequent, event-related trades across a variety of asset classes, or integrating a structured-product design with long delta equity, etc). And even then, you'll have to construct the approach yourself. Baird is as good a place to start as any to understand how to make markets, which I think is the type of trading you're interested in, at least by inference. Not necessarily the most common approach of retail, however. I understand you're not trying to be a MM, it's just the mindset of such that I'm addressing. In any event, think about my former suggestion to start a trade journal. Hopefully when you sift through the chaff, you'll get enough wheat to make it worth your effort.

Brilliant...