Thanks for the post @PeterOhlson . Forgive my ignorance, but basically you are long a straddle, and short an OTM call and short an OTM put, right? So, this is a debit spread--but isn't it profitable because of the recent directional move down, and not because of theta decay? In other words, assume SPX had moved nowhere since Dec 9. Would your trade be profitable still?
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Market friction issues aside, accd. to black-scholes the profit from deltahedging far OTM options should be much larger, percentagewise (you keep more of the premium), because of skew. Basically far OTM options have a massive theta/gamma ratio (high IV), which requires much less re-hedging than say a straddle, and thus you keep more of your theta profits. The flipside is that a high IV on OTM options (skew) is pretty much just a way for the BS-model to deal with non-lognormal distribution of prices.
I'm long the straddle in the far-month (Jan03) and short OTM premium in the near-month (Dec20). The straddle is further away from expiry, plus it's ATM, so it has low IV (not affected by skew) and low theta (from being far out). The opposite is true for the OTM positions. It was initiated Dec 9 when ES was around 1805. After the recent upmove yesterday, ES is back around there, which gives us a good opportunity for comparison. I have attached the same charts as I did previously, after the recent upmove yesterday:
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As you can see, the bull put spread to the right had massive drawdowns on the downmove. The other structure did not. Consider risk-adjusted return. The bull put spread had massive drawdowns for little profits. Again delta hedges are not shown. But with deltahedging the other structure would be up $1.1k for 11 contracts from a total of one hedge for the entire period. I will need to calculate deltahedges for the bull put spread and get back, but logic assumes that since the theta/gamma of the bull put spread is terrible (requires more hedges), and loss per deltahedge equates to (1/2)*gamma*S^2, it's not too good looking.
EDIT: Okay after some crude calculations, the other structure is up $1.2k on 11 contracts since Dec9, deltahedged. ($1.2k / 11 / 50 = 2.18 per structure)
The bull put spread is up $600 on 22 contracts since Dec9, deltahedged. ($600 / 22 / 50 = 0.54pt per structure)
For good measure I threw in the 1805 Dec20 straddle as well, 4 contracts would be up around $50 ($50 / 4 / 50 = 0.25 per structure) (this one got unlucky and introduced a hedge right at the bottom)
This is very crude obviously. *sigh* wish I had a database of all options on the S&P space, with IVs and all the greeks, where you could backtest by attaching automatic deltahedges to test profits of various structures through time, the structure being defined by some variables like % OTM, delta, theta/gamma and the backtest automatically opening the structure at the beginning of each new cycle. Because of my lack of Goldman Sachs like infrastructure I'm forced to use Excel and my brain along with the rest of us unwashed masses. Sucks
Last edited by PeterOhlson; December 19th, 2013 at 03:05 AM.
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While not a hard core options trader myself I'm both very familiar with the math behind BS and have worked beside some very good option traders. Your Theta/Gamma Ration discussion is something I've never heard of before, but something I find extremely interesting. Thanks for the insight. Time to build some spreadsheets.
Thanks, yes to me the theta/gamma ratio is a way to view the "IV" of a portfolio of options. The higher it is the higher the potential profits are. Obviously it's neccessary to observe how the risks of whatever structure you come up with changes through time, a good understanding of sticky strike / delta and how the term structure moves is neccessary. For instance there is no logic in viewing the vega of an OTM calendar because short-term vol-of-vol moves at higher rate than long-term vol to some extent. In addition you should never sell and hedge DOTM options if you don't intend on holding them til expiry, because potential moves against you would blow up their value (due to vanna / vomma: see The Option Workshop) and your "stoploss" would be much much worse than what you'd expect if you're not familiar with these measures. If you hold to expiry you only take mark-to-market exposure. These are all "little things" that are central to understand in addition to black-scholes IMO.
If you buy calls you expose yourself to vega, theta, gamma risks of the call. The underlyer only carries delta-risk thus it's a more "pure" delta hedge to use underlyer. Inverse correlated is fine, but watch out for negative compounding / tracking errors if holding long-term.
Last edited by PeterOhlson; December 19th, 2013 at 03:27 AM.
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Since the Natural Gas conversations seem to have stopped I'm guessing you guys all got out.
For what it's worth
19-Dec EIA Release Estimates.
Based upon 37 estimates...
Range -228 to -283 Std Dev 11.7
Note that several of the major surveys have averages close to 260, but they have smaller data sets.
2012 EIA Report -70
6 year Average -133
I believe largest withdrawal in December was 208 and the largest withdrawal ever 274.
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