A couple things. Since I am basically net neutral long volatility, should I really care whether the IV increases or decreases during the 5-week expiration cycle--as long as the descent on the underlying is steady and not abrupt? Also, suppose I stagger my entries over several near-strikes, would that improve my chances for profit? Lastly, I am looking to exit the spread once the near-month option realizes 80% of its profit potential--is this reasonable? In addition, I was thinking about a stop-loss of about 12 points ($600.00 per spread). I arrived at this figure by figuring that the average profit per spread would be about 12 points ($600.00 per spread)--is this reasonable? Thanks for the input.
Vega Neutral Strategy
- Thread starter jwcapital
- Start date
You may be neutral volatility now, but that changes as the futures move. The closer you get to expiration, the more dramatically it will change as the futures move.
Usually it takes about a half-hour with visuals to explain this, so it's a little tough in this medium. But look at it this way. Imagine futures are at 1000. The 1000 puts are at the money, and they have twice as much vegas as the 900 puts. So to get vega neutral you sell 100 1000 puts and buy 200 900 puts.
Futures go down to 900. Now your 900 puts are at the money. They now have twice as much vegas as the 1000 puts. And you own twice as many of them. So suddenly you are no longer vega neutral, you are VERY LONG VEGAS!
Since you're spreading across months, it gets even more dicey because in a sense you're spreading apples against oranges.
That's a technical greek-oriented way of looking at it. We can also just eyeball your spread. At expiration, let's imagine the futures are at 700. Your short 795 puts are now pure intrinsic value - you've lost 95 points ($4750) on them. There's no time remaining so it doesn't matter what the IV is in that month. The only thing now that determines your total loss is the IV on that 700 put, which still has, say, 30 days remaining. If volatility is at 100% your call is worth about 80 points, so you haven't lost much overall. But if IV is now 30% that put is worth only 24 points, and you've lost 95 - 24 = 71 points.
All of which is a very long-winded way of saying YES you should really care whether IV increases or decreases over the next 5 weeks. Getting premium neutral is a start, but you have to understand the limitations of premium neutrality and how those premium relationships between strikes and between months will act as time passes and the futures move. As you get close to expiration the premium relationship between strikes breaks down completely.
No problem. Started tracking the NOV P795/DEC P700 on Friday, October 17th. At the initial look, the NOV P795 sold for 25 and the DEC P700 cost 19.00; hence the credit of 6.00. In addition, the spread can make more money if the underlying, at the time of expiration, finishes at the NOV strike. The 6.00 credit is the absolute floor. Remember, this spread is bearish and require steady, not abrupt downward move toward the strike. Since I do not have enough experience with this spread, I simply assumed that the average profit would be 12 points. So, I look for a 1:1 risk to reward. Assuming the underlying finishes above the NOV strike at expiration. I will have gained 25 points, and the DEC put will still have some value, so when I sell it at NOV expiration, my profit will be higher than the 6 point initial credit. Once I get through the next four weeks, I will have a better handle on average profit for the spread as well as an appropriate risk:reward.
ThinkOrSwim analyze tab. www.thinkorswim.com often referred to as TOS.
I was looking at some similar diagonals, and asking some questions about it. No one seems to have done much studying of this type of credit diagonal.
I have tried small positions like this 7 times now, and each time I have gotten in for too little credit, and then gotten out for too little credit. But at least I got a credit on both sides.
A few observations that I hope someone will correct or add to:
1) It helps when the front month has more volatility than the back month. This may occur on a stock with earnings.
2) The position moves from a credit to a debit when the underlying moves away.
3) It seems to have a high probability of success, but a low return on risk.
4) It should be possible to do this on both sides (double diagonal) to double the return on the capital at risk.
5) I always have cash available to pay for the maximum loss (95 in your case) so that big moves and changes in margin won't affect my plans.
6) I THINK that we can still use double diagonal adjustments if the position gets into trouble (like below 800).
7) I would guess that this position would still be better entered in a lower volatility environment.
Let me know if you see another situation becoming available. I plan to make these a part of my trading plan, unless you guys can talk me out of it.
I was looking at some similar diagonals, and asking some questions about it. No one seems to have done much studying of this type of credit diagonal.
I have tried small positions like this 7 times now, and each time I have gotten in for too little credit, and then gotten out for too little credit. But at least I got a credit on both sides.
A few observations that I hope someone will correct or add to:
1) It helps when the front month has more volatility than the back month. This may occur on a stock with earnings.
2) The position moves from a credit to a debit when the underlying moves away.
3) It seems to have a high probability of success, but a low return on risk.
4) It should be possible to do this on both sides (double diagonal) to double the return on the capital at risk.
5) I always have cash available to pay for the maximum loss (95 in your case) so that big moves and changes in margin won't affect my plans.
6) I THINK that we can still use double diagonal adjustments if the position gets into trouble (like below 800).
7) I would guess that this position would still be better entered in a lower volatility environment.
Let me know if you see another situation becoming available. I plan to make these a part of my trading plan, unless you guys can talk me out of it.
Are there any traders out there willing to share some insights on trading vegas. Most of the time, you hear traders putting on positions which take advantage of decay thru flies/condors which is vega flat or take on positive/negative deltas like verticals which is also vega flat.
I don't read much posts which seek pos or neg vega exposure specially neg vega positions, while maintaing neutral on the other greeks. any reason why?
Thanks
I don't read much posts which seek pos or neg vega exposure specially neg vega positions, while maintaing neutral on the other greeks. any reason why?
Thanks