what is the best way to trade skew while hedging delta, gamma, vega, and theta?

[njrookie1]

One again, I agree with sle that normalizing by ATM IV is a good idea since it breaks down the positive link b/w level and skew, and make econometric/statistical modeling easier since you can model two processes separately without worry about joint dynamics.

Think like this: it is normal for skew to be 6 vol points b/w 25 delta and 75 delta when 50 delta IV is 30. but when 50 delta vol is 80, 6 skew points are nothing, while 16 points, which is still 20% of ATM vol is the more likely scenario.

sle: is my interpretation of your statement "if vol level and skew are correlated, you are not normalizing them correctly" now correct?

njrookie

 

[sle]

Quote from njrookie1:
sle: is my interpretation of your statement "if vol level and skew are correlated, you are not normalizing them correctly" now correct?

yep. is your PM working yet - it would be interesting to compare the statistical methods we are using

 

[MBC]

Quote from sle:

Not true. In general, "pure" options traders trade volatility, which can either be a true directional bet (e.g. if you are long vega, you are short the market) or could be truly market neutral (e.g. a collar skew position is a bet on volatility dynamics with respect to spot and not much else).


All he's doing is re-normalizes the vol surface by the ATM volatility X = Vol(K)/Vol(50d).

Anyway, trading skew is a very "adult" topic, since it's a very shady risk premium. I, personally, have worked out a lot of gimmicks and models for it, but your mileage may vary.

Yes. Then just trade the underlying then ?

OR

Make the market via bid/ask spread for the hedgers of the world.

Other wise no different then trading flat price directionally. Why get into all the subterfuge of skew gamma etc....

 

[njrookie1]

PM is still not working for me somehow. cannot send or receive. love to talk about models too.

it says

"Your administrator has disabled private messaging."

I am not sure what I have done to deserve this kind of treatment

njrookie

 

[newwurldmn]

The put a floor on the number of posts you have to put publicly before private messaging is enabled. It's in the Feedback section. Something about some disgruntled guy using a new account spamming people...

 

[njrookie1]

thanx for the clarification. needs to get the post counts up.

 

[steven149]

I have to say this technique is new to me but I found interesting from this thread. It may be worth taking a closer look. I pulled some online presentations on implied and volume. There are insights in the relations. It sounds there is money to make once a model is developed. The OP also iterates that as the size allows, profit is not a problem. My question is that, unanswered from my online research, how much return we are expecting in one trade here? I am not thinking about volume trade as that would include other factors.

P.S.: although I've done searchings, are there other good reference on this?

Thanks.

 

[sle]

Quote from MBC:
Yes. Then just trade the underlying then ?

Are you asking "why trade volatility?" or "how to trade volatility in a non-directional manner?"

The first one is obvious - in trading volatility, you could come up with a stream of alpha that other people might be missing and/or leaving untapped.

The second one is less obvious and requires thought - is there a way to structure a position that should make money in most market environments? The answer is yes, but it's not straight forward.

Quote from MBC:
Make the market via bid/ask spread for the hedgers of the world.

There are succesfull hedge funds out there that are dedicated purely to trading volatility and they are, generally price takers (albeit very spivy ones at that). Do you think that you are smarter then all of these people?

 

[steven149]

Quote from sle:

Are you asking "why trade volatility?" or "how to trade volatility in a non-directional manner?"

The first one is obvious - in trading volatility, you could come up with a stream of alpha that other people might be missing and/or leaving untapped.

The second one is less obvious and requires thought - is there a way to structure a position that should make money in most market environments? The answer is yes, but it's not straight forward.


There are succesfull hedge funds out there that are dedicated purely to trading volatility and they are, generally price takers (albeit very spivy ones at that). Do you think that you are smarter then all of these people?

I was referring to the second part. From your answer, it is indeed not straight forward. But it is encouraging.

I don't want to compete with those who deal this all day long. I probably won't adopt their approach either. But I do want to know what their approaches are (in public sense, no trade secret). That is their game.

Thanks for the remark

 

[MBC]

Quote from sle:

Are you asking "why trade volatility?" or "how to trade volatility in a non-directional manner?"

The first one is obvious - in trading volatility, you could come up with a stream of alpha that other people might be missing and/or leaving untapped.

The second one is less obvious and requires thought - is there a way to structure a position that should make money in most market environments? The answer is yes, but it's not straight forward.


There are succesfull hedge funds out there that are dedicated purely to trading volatility and they are, generally price takers (albeit very spivy ones at that). Do you think that you are smarter then all of these people?

Stream of Alpha that might be missing. Agree, key word might be. I.E. you are guessing using options, just as guessing using underlying regarding under value commodity or equity for example. Just a different method of betting on future thats all. I have been around these Vol. traders, they are no different then any other trader when we talk returns over period of time. They have good years and no so good.

No smarter than anyone. Just asking questions thats all. Why defensive ? I amjust interested in learning what exactly differentiates Vol. trading from any other guess ? Vol. trading while making markets ( not price taking) but offering the bid ask can be interesting..... basically a market maker in a niche market, can be nice.