UK's Osborne to make Brexit statement before markets open on Monday
"British finance minister George Osborne will seek to reassure financial markets on Monday following the country's decision to leave the European Union last week, setting out the government's economic response to the vote in a statement at 0600 GMT.
Global stock markets lost about $2 trillion in value on Friday after Britain voted to leave the EU, while sterling suffered a record one-day plunge to a 31-year low and money poured into safe-haven gold and government bonds."
The topic has moved on a little since I logged in, so apologies for quoting such an old post, but I think it represented a great opportunity for a decent risk / reward trade.
The trade had the following going for it:
Complacency in the markets - everyone expected the UK to remain even though the polls were close. Markets moved up and IV did not really spike.
A catalyst with a very specific date - Everyone knew when the vote would be held.
Potential for a shock - If Britain exited the EU, it was quite clear that it would lead to a short-term shock (to me at least).
Implementing a trade for this scenario did not require massive capital - I am pretty sure it could have been done with decent risk on a $10k account, although you would make less use of different option strikes.
So, how would we implement this trade? I should have done it as follows:
Buy some put options (ATM) expiring a week after (or on the Brexit date) in the SPY.
For half of the above position, sell puts a couple of strikes down. This creates a put spread and is mostly use for 2 reasons, a) if the trade does not work, then you lose less premium (risk is lower) and b) when prices don't make a large move, the put spread can provide a decent gain since its capital outlay is lower.
Buy some call options in gold stocks or a gold ETF (ATM) with the same expiry as above.
For half of the position, sell calls a couple of strikes up.
Buy a smaller number of longer dated puts in the SPY and a smaller number of longer dated calls in the gold stocks / gold ETF. These are held for a longer term play.
The basic idea behind the trade is to make as much money off sharp moves as possible. Buying normal calls / puts tends to be quite expensive when IV is high, therefore I would use a put-spread to reduce the cost (risk) somewhat. The short leg of the put spread means that IV is not such a major concern as you sell the option at high IV as well. Of course, you need to limit risk by only having exposure (net premiums) to a low % of your portfolio since you can lose all of the premium you paid.
Your highest exposure will be to the spreads, followed by the shorter-dated options and then a much smaller position in the longer-dated options.
If the markets move against the position, the trade loses and the net premium is the loss.
If the markets make a smaller move, then the put / call spreads will make some money which can hopefully offset the cost of the long puts / calls.
If the markets make a larger move, then the put spreads will have their profit maximised which could be good or bad, depending on your chosen strikes. The long puts / calls then stand the chance to make decent gains and this is really where the trade shines.
I also would have added the longer dated puts / calls into as they sometimes make quite decent gains over time, but you need a sustained move for this to work.
Obviously the choice of strikes and the sizing of positions has a huge impact on this trade, but I can swing this in my account with reasonable risk. I think trading this way is actually more viable for smaller accounts, than trying to trade S&P futures. Risk is always limited, number of trades are limited and frequent stop-outs are avoided since a trade like this should not get whipsawed.
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You can think of the entire position as being short the SPY. Traditionally, you would short the SPY, use a stop-loss and just exit if it reaches your stop point. The downside to this is that you can be whipsawed quite a bit around your entry point.
Using options, you can avoid the whipsaw since you maximum loss is predefined. However, this comes at a price and therefore the SPY needs to move down by a certain percentage before the trade becomes profitable. You are exchanging the uncertainty surrounding multiple whipsaws for a lower (worse) entry price on your short. Another benefit is that you have no gap-risk - the SPY can jump by 100% overnight and my loss will be the same.
The use of put-spreads removes the unlimited profit potential from those options, but reduces their cost. They work great for short-term plays where a catalyst is involved, but in this case their goal is to try and provide a profit to the position if the market does not move down enough to offset the lower entry price of my short (as per the above paragraph).
The use of longer-term options can provide a nice profit if the markets continue in the direction. It is just there to provide a potential profit for another scenario, i.e. the market did not fall sharply, but traded down slowly.
The play in GLD assumes that if SPY falls, GLD will rise. It could be seen as redundant since you could just do the SPY trade on its own - in my situation, long positions (long calls and not long puts) can be better for tax reasons.
Thus, the trade is really not much different than a short position with a regular stop-loss.
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