Either, as long as I can forecast it correctly. But yeah, I should have just stuck to the original example for simplicity, so let's go back to that.
What's the best strategy for being bearish on volatility without gamma hedging
- Thread starter Ghost of Cutten
- Start date
Either, as long as I can forecast it correctly. But yeah, I should have just stuck to the original example for simplicity, so let's go back to that.
Ok, the slight problem there is your risk is rather high in the event of some market shock. Would it just be a case of doing bullish vertical credit spreads at the bottom, and bearish vertical credit spreads at the top then?
Thing is, whenever I've looked at those trades, they seem to suck. If you can call the top of the range, why not just buy puts or a bear put (debit) spread? It seems like the superior payoff will more than compensate for any losses on time decay, especially with a debit vertical spread.
What about if it's in the middle of the range?
Well, you can't have it all and a free lunch with a cherry on the top, sire...Quote from Ghost of Cutten:
Ah, maybe I forgot to explain properly - I mean you would exit the put spread near the bottom of the range, before you put on your bull call spread. Essentially you'd be making bets on moderate falls when the range is at its highs, and vice versa when at its lows. The spread would be used to keep the vol exposure moderate, since you expect it to decline.
I have tried with butterflies, but the problem is that your results at expiry depend so much on luck, what if its at the bottom of the range at expiry? You would be right on the range, right on falling vol, and still have a bad result. If you use iron condors wide enough to avoid this risk, your return kinda sucks. Plus you have those wonderful 4 commissions and bid-offer spreads to pay
At least with the vertical spreads, it is fairly obvious what to do. I'm fine with taking a directional view, since I would only put these on when I think I can anticipate it to some extent.
Reason I don't want to gamma hedge is I would only put on short vol positions when I'm pretty confident about a range - if I'm wrong then the other spread leg will cap the loss.
Someone might suggest just using outrights. The problem here is your outlier risk in case of some news event; and the risk of being faked out if there is a false breakout for a day or two. Trading ranges are notorious for triggering stops at either end, then reversing a few days later to re-enter the range. Having on a limited-risk options position lets you sit through such noise with impunity.
Disclaimer, I am a total noob at trading volatility, so I am probably missing some fairly obvious stuff here.
Essentially, all these strictly limited downside, short vol trades that I describe, whether they be flies, condors or iron millipedes come down to the same general idea: you commit a certain amount of premium, the loss of which plus transaction costs is your downside. In return, you get a certain range that you've pinned that offers you a certain payout. If you're proved right about the distribution at or close to expiry and the mkt is wrong (i.e. the mkt underestimates the "mass" in the range you're pinning), you make money.
To be sure, this is all in terms of terminal distribution, so you have to arm yourself with a lot of patience. Also, what you pay on the way in is crucial as it determines your r:r. None of it is rocket science and occasionally these things get cheap enough that they become worthwhile lottery tickets. For example, I have done some of these wide flies in Eurodollar reds recently, trying to pin the area arnd the 97 strike. Again, just my Z$2c.
Direction is the main course. IV is gravy.
If you can reasonably predict a trading range, the most bang for the buck comes from the underlying or long options. The UL will give you $ for $ when right (or wrong).
Long options have lower delta, time decay and potential IV issues. Since you indicated an ability to forecast IV, then delta and decay are your adversaries. In return you get leverage so if your UL move is decent, you have leverage.
Anything involving short legs to hedge (vertcals, butterflies, condors, etc.) is going to have a limiting feature thereby reducing your already sub 1.00 delta gains even further. The tradeoff is that if dead wrong, the loss is less.
Sell strangle and walk away.