Vertical Spreads

[spindr0]

Quote from Maverickz:

Definitely direction is first, time frame is second and volatility is third but can't be ignored either. While you are correct that volatility is not really predictable, you can still play the probabilities here by comparing IV to historical volatility(HV). If it is significantly higher than average then I look for plays where I sell premium that matches my direction and time line. If IV is very low compared to HV then I look to buy premium while making my direction and time line. When IV is around the middle somewhere I try to stay near Vega neutral since I don't know where it might go.

We're in agreement about this. Predicting volatility is one thing. Playing it is another.

I'm primariliy an equity trader now but when the things I do are slow (the stocks, not me ), I look for option situations (usually EA's) where IV is greater than HV and there's a decent skew b/t the 2 front months. Mostly ratioed double straddles, double diagonals since I hve no clue where the UL is going - just a fair idea of whrere IV is going. Sometimes if very close to expiration, double reverse calendars if 2nd month is higher than usual... tho I haven't been finding as many of them as there used to be. Have no idea what has changed to cause that but that's the end result.

 

[jb514]

Quote from Maverickz:When volatility is very low debit spreads (spreads you buy) are preferred. When volatility is very high then go with credit spreads (spreads you sell). With volatility in the middle ratio spreads, condors, and butterflies with lower Vega are preferred.

What is the point of choosing a debit spread vs a credit spread when they give you the same p/l graph. When volty is low you should be buying and selling when volty is high. But if credit and debit spreads give you the same p/l, what is the difference between buying and selling?

 

[Maverickz]

Quote from jb514:

What is the point of choosing a debit spread vs a credit spread when they give you the same p/l graph. When volty is low you should be buying and selling when volty is high. But if credit and debit spreads give you the same p/l, what is the difference between buying and selling?

All spreads are not verticals. For instance when volatility is low consider a Bull Call Diagonal, a Bear Put Diagonal, or a double diagonal. These plays can take advantage of the rising volatility difference between the front and back months. I also really try to avoid unlimited risk plays as much as possible.

 

[jb514]

Quote from Maverickz:

All spreads are not verticals. For instance when volatility is low consider a Bull Call Diagonal, a Bear Put Diagonal, or a double diagonal. These plays can take advantage of the rising volatility difference between the front and back months. I also really try to avoid unlimited risk plays as much as possible.

I don't understand why we would set up a diagonal if we thought that. I think you are saying, that if we think implied volatility is low, we would short the current month, a go long the next month since rising volatility will cause the price of the long to rise.

Wouldn't it make more sense to buy the long position now wait for volatility to go up and then sell the short to create a vertical?

 

[Maverickz]

Quote from jb514:

Wouldn't it make more sense to buy the long position now wait for volatility to go up and then sell the short to create a vertical?

Yes that is completely acceptable and may even be more likely in the case of buying a call or put when volatility is low. On the high side, as previously mentioned, I really don't like selling naked calls or puts though...although I do occasionally do it. It really is just personal preference.

 

[jb514]

Quote from ForexForex:

But what about the horizontal risk, have you thought of that? You got to cover the horizontal positions.

What is horizontal risk? Do you mean the actual cost of the long option?

 

[jb514]

Quote from Maverickz:

Yes that is completely acceptable and may even be more likely in the case of buying a call or put when volatility is low. On the high side, as previously mentioned, I really don't like selling naked calls or puts though...although I do occasionally do it. It really is just personal preference.

Buying when low, and then selling when high to create a vertical doesn't involve and naked puts or calls. Why do you keep bringing them up?

 

[Maverickz]

Quote from jb514:

Buying when low, and then selling when high to create a vertical doesn't involve and naked puts or calls. Why do you keep bringing them up?

I am referring to to selling naked calls/puts when IV is much Greater than HV. In other words when there is (historically speaking) extra premium built into options from volatility it is normally a better time to COLLECT premium. This means SELLING options not buying. Since I don't normally like naked call/puts unless I am extremely confident about direction and time frame.