The hardest thing to learn about options is trading vega. The area that usually trips up most folks with a little bit of experience (and sometimes some book learning) is volatility between different expiration cycles. If all you look at is the Greeks and you are trying to hedge vega in one series, you might see some vega in another series that looks like the perfect counter value that will protect your initial position. but it just doesn’t (or rarely does) work out. Short 10 vega in front month options cannot be hedged or neutralized with short 10 vega in a back month.
To me the simple exercise I walked through is the best sanity check on these types of trade: basically ask yourself what the positions benefit from or lose from and then see if pushing the trade to expiration time on the earlier expiry makes the results look the way you really want.
You ask about what would be a prudent trade if you don’t have an opinion about volatility. Well to me the most prudent thing is to not have an opinion about volatility. Basically that means just taking some kind of small initial position that has defined risk and decent reward potential and then wait to see if you are right or wrong. If you are somehow right , work to make the trade a risk free one. If you are wrong, use that very good market message to change the position into something more in tune with what the market is actually doing (versus any preconceived opinion about it). in general, trying to hedge vega will almost always get you into trouble in that you will either wind up doing some doubling or tripling down (which is in effect what was happening with your condor/calendar trade) or just getting so hedged that you can’t make money. In my experience the best hedge is to keep your position size manageable and then be a nimble trader as the market dictates or allows.
Best,
m
From: OptionClub@yahoogro
Sent: Monday, June 07, 2010 10:43 AM
To: OptionClub@yahoogro
Subject: Re: [TheOptionClub.
I see... these are some very good points that I did not think of (hence the reason I posted the question in the first place), but of course your comments have lead to intrigue and confusion :-)
I can now see that the two positions where not exactly apples to apples ("Calendar was more like a five point wide fly") and that since increasing IV over a six weeks period from this higher level of IV would most likely be a move down and outside of the profit range any way - so the vega hedge using the fly against the calendar was pointless (since this was initially to become vega neutral if that is a term or even possible).
So lets whittle the question down to what I really meant to ask - if you do not have a IV forecast and IV is currently halfway between support and resistance (or some other TA) then would it make sense to attempt to make an income trade like a fly or calendar vega neutral? (at least initially). I bet the more prudent trade would be to wait until you had an opinion about IV, but I thought I would ask anyway.
Thanks,
Joey
On Sun, Jun 6, 2010 at 11:15 PM, mcatolico <mcatolico@mindsprin
I look at calendars and flies as basically the same trade. I say this in terms of the basic “what you want to happen” common sense version of trading strategies.
In either your 125 calendar or 125 fly you basically want the same thing: ibm closes exactly at 125 at july expiration. If that were to happen the fly of course would be worth $10 and the net profit would be 6.23. compare that to the calendar. If ibm expires at exactly 125 at july expiry then the jul call is of course worthless and the remaining oct 125 call would be worth whatever the IV at the time would be. To equal the profit on the fly, the oct call would need to be trading at or above 9.78 (your initial 3.55 debit plus the 6.23 profit on the fly) to equal the july fly trade’s profit. To get to that price with ibm’s dividend thrown in that would mean IV has to be about 35-37% which is higher than it is today. So think about that a second, you basically are entering a position that wants ibm to do absolutely nothing for the next 6 weeks or so and , with the calendar, you want IV to rise. Under almost no scenario is that likely to happen.
Now the calendar does not exactly equate to the ten point wide fly you have as the supplement to your trade, it’s more like a five point wide fly. But even so hopefully I’ve shown that the calendar is really a trade that is strategically very similar to a fly but with a contradictory wish for volatility to increase while price action peters out. If your forecast is for trendless action, you’re much better off simply going with the plain old fly in my opinion.
From: OptionClub@yahoogro
Sent: Sunday, June 06, 2010 10:51 PM
To: OptionClub@yahoogro
Subject: [TheOptionClub.
One of the disadvantages of calendars is they are a + vega trades so if IV drops by a significant amount then you loose money.
So in this time of increased volatility would it be dumb to place a Calendar + Butterfly combination trade?
Let me give an example:
IBM - $125.28
Calendar BUY +1 IBM OCT 10 $125 CALL
SELL -1 IBM JUL 10 $125 CALL
DEBIT $3.55
DELTA 0.35
GAMMA -1.66
THETA 2.37
VEGA 13.19
Bitterfly BUY +1 IBM JUL 10 $115 CALL
SELL -2 IBM JUL 10 $125 CALL
BUY +1 IBM JUL 10 $135 CALL
DEBIT $3.77
DELTA -7.96
GAMMA -2.51
THETA 2.75
VEGA -10.49
Combined
DELTA -7.61
GAMMA -4.17
THETA 5.12
VEGA 2.70
This lowers your vega from 13.19 to 2.70 and the interesting part is if you simulate IV increasing by 10% you make money and if it drops by 10% you make money.
You have a little more -delta now but that could be offset by buying 7 shares of stock.
Ok so outside of the stock moving outside of the profit zone... what am I missing here? I realize the greeks change but adding or subtracting some positions can adjust for these changes. This looks like a pretty good way to make money (I know that must sound pretty sophomoric).
Thanks in advance for any input.
Joey
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