verticals

[heiasafari]

What you are proposing is a very simple concept... Basically you do short put spreads and short call spreads. And if you combine both then you've got an IC.

It is rightly pointed out by others that this strategy has a limited risk and IMO is infinitely smarter than going naked short. It requires less margin per $ premium you take in so it increases your potential return.

However what it cannot do is substitute a limited downside risk for smart risk management. It is a good strategy but if you get too greedy because you think risk is limited and that your margin allows you to take much larger position.... well then in the end a black swan will end up killing you anyway.

You can ratio it for added protection. If you are kind of new to this, you should check Mark's blog for ideas and info about managing such vertical credit spreads.

 

[Martinghoul]

Quote from spindr0:

If strikes K1 and K2, and
P = net premium received
then

ABS(K1-K2)-P = 1/2 the number of dead swans

The important question to ask is whether they are black or white.

Moreover, just thinking out loud, they could actually be Schroedinger's swans, both alive and dead, black and white at the same time...

 

[spindr0]

Quote from Martinghoul:

The important question to ask is whether they are black or white. Moreover, just thinking out loud, they could actually be Schroedinger's swans, both alive and dead, black and white at the same time...

Rumor has it that due to the severe decrease in availability off black swans, Lipizzaner stallions will now be substituted for those who prefer black and white. Giddyup!

 

[xflat2186]

Here is a related question:

If a white swan is in the water and then jumps out of the water only to stumble and fall into the mud thus appearing brown how would that effect the huge inherent edge that sellers have in options on carbon credits?

I am considering taking a large position in carbon credits

 

[pjhaggerty]

so, the main danger is in getting too cocky with it and increasing your risk exposure on each trade too much? All you have to do to be effective is be disciplined in only putting, say, 3% of your portfolio at risk on each trade and you'll be fine?

That way you can bank the small wins and when the one really big, but highly unlikely, loss comes you can absorb it as a small percentage of your portfolio overall?

If trading this strategy, what are some good position sizing/risk management techniques (without changing the spread)?

 

[MTE]

Quote from pjhaggerty:

so, the main danger is in getting too cocky with it and increasing your risk exposure on each trade too much? All you have to do to be effective is be disciplined in only putting, say, 3% of your portfolio at risk on each trade and you'll be fine?

That way you can bank the small wins and when the one really big, but highly unlikely, loss comes you can absorb it as a small percentage of your portfolio overall?

If trading this strategy, what are some good position sizing/risk management techniques (without changing the spread)?

You are missing the point here, verticals like individual options are fairly priced in general so in the long run you are gonna lose money due to commissions and slippage.

Risk management/position sizing is an important part of the profitable trading approach, but it's not everything. You still need some method of timing the market or choosing the "correct" strikes prices.

 

[ivanbaj]

Quote from pjhaggerty:

so, the main danger is in getting too cocky with it and increasing your risk exposure on each trade too much? All you have to do to be effective is be disciplined in only putting, say, 3% of your portfolio at risk on each trade and you'll be fine?

That way you can bank the small wins and when the one really big, but highly unlikely, loss comes you can absorb it as a small percentage of your portfolio overall?

If trading this strategy, what are some good position sizing/risk management techniques (without changing the spread)?

This will involve some directional and volatility guesses.

It should help to sell when volatility is relatively high and you expect that it will go down to the expiration date.

You have to mind the spread. If the options are not very liquid the spread can be a problem. You have to do 2 entries and 2 exits with tough spreads.

You could enter sell one leg when the price is closer to that strike and buy the other on a pull back from the second strike. Taking the chance that between you are completely exposed to the Swan.

Also a diagonal spread can be considered. Can someone compare both?

 

[MTE]

A diagonal spread adds another dimension, namely a intermonth volatility spread.

 

[spindr0]

Quote from xflat2186:

If a white swan is in the water and then jumps out of the water only to stumble and fall into the mud thus appearing brown how would that effect the huge inherent edge that sellers have in options on carbon credits?

How many legs does it have?

 

[spindr0]

Quote from pjhaggerty:

All you have to do to be effective is be disciplined in only putting, say, 3% of your portfolio at risk on each trade and you'll be fine?

It's a bit helpful if the underlying in your bullish spreads go up and the underlying in your bearish spreads go down.