What do you mean by spread trading?
Volatility trading IS directional
- Thread starter TheBigShort
- Start date
What do you mean by spread trading?
Thanks for the reply. A spread on implied vol. Ie a dispersion trade, calendar trade etc...
Sure. I’ve traded a lot of that. Pretty much all vol traders do.
I understand, but I was wondering if you could give a specific example of when you traded the spread. Did you delta hedge etc...
It might seem to have a correlation of (minus) 1... but that isn't always the case... you should be very careful with any strategies based on this.
Individual stocks IV and movements should be even less correlated...
Implied volatility is based on the expected (near) future moves in the underlying, based partially on the past. Those moves can be up or down. Large moves up during an extended period of time will also cause the IV to go up... but generally speaking IV will go up in stress/panic periods.
Also, any correlation will not last, since stocks/indices can go up indefinitely, while IV will generally have a lower boundary which makes sense. If a stock continues to go up 0.5% daily... you would see an IV of about 10-12% as a bottom and possibly stay there for an extended period... so any correlation in those two will go to zero in that case.
For all practical purposes they can go down indefinitely too.
I learned this watching precious metals in the 1990's. Something can lose 10%. If you buy then, you can lose 10% more. If someone else buys then, they can lose 10% more. Then the next buyer can lose 10% more. ... and ... pretty much that can happen indefinitely. After it happens over and over the original buyer, you, might only be down 50%, 60%, or 80% ... but no matter where you're at, the new buyer can still lose 10% from whatever the price is. There's no practical limit to how many buyers can lose 10% from any price.
I've heard people wonder aloud why nobody bought silver when it was at 5$us-7$us/oz ... that's why, because it had fallen for a VERY long time (decades) and even at 7$us/oz ... you could still lose 10%, and another 10%, and another 10% ...
A common trade is SPX volatility vs SX5E volatility. You would delta hedge to isolate the vol risk.
Other times I have done spread trades where I don't delta hedge the position.
At the end of the day, there are two reasons to "spread:"
1. To trade the relative value of two assets
2. To isolate a risk factor (or hedge out a risk factor).
Trading SPX/SX5E is an example of #1.
Trading a calendar spread is an example of #2 where you want to isolate the forward vol.
Being long VIX call options is better than being outright short stocks. VIX tends to have a lower bound, and VIX requires smaller and smaller SPX pullbacks to spike as the SPX rally continues
Vix has significant carry costs.
It does, plus the CBOE VIX options have to be timed almost right on the dot. These options can be 6.00 ITM yet still be traded at prices significantly less. Not saying I don’t like using them ever but, timing can be an issue.
I’ve always kind of thought all volatility strategies though are higher cost, or tie up a bit of capital for the potential returns.