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Using options to follow the movement of the futures
long put + short call = synthetic short the underlier
long call + short put = synthetic long the underlier
snap to a few minutes later:
risk profile long 1 /ES:
risk synthetic long 1 /ES:
So theoretical risk characteristics are the same, but as demonstrated the actual price movement is not. If I remember or someone prompts me we can look at this later today or in a few days to see how price of the synthetic and the underlier compare.
If you are going to try this I suggest NOT the /ES or not any future. Maybe 100 shares of SPY or one of the sector spdrs that has a lower price. XLF, maybe.
Can this be done effectively, yes. A pro with lots of experience could try to leg reversals (synthetic long + short underlier) and conversions (synthetic short + long underlier) as an arb or quasi arb strategy. That venue is dominated by people that will take regular guys to zero and buy their foreclosed homes then hire the wives to be the cleaning crew.
in the example you have given which is - long call + short put.
If I just look at this trade in itself, can i say that the short put is there so it might compensate for the time decay of the call in the event that the future contract rises over time? otherwise it is better to just buy the call.
I am definitely not think of using options simply to outright trade the futures directionally. I am exploring if i can incorporate options into my trade in certain market situations which would be able to either limit the downside or amplify the upside.
"I am definitely not think of using options simply to outright trade the futures directionally. I am exploring if i can incorporate options into my trade in certain market situations which would be able to either limit the downside or amplify the upside."
That is an express function of the options market...a primary purpose.
The short put in the example above is part of the synthetic long. It is the part that brings in premium, but it also creates the obligation to buy if the underlier is higher.
Without the short put the risk characteristics are quite different.
Two basic pricing conventions, In fact, part of how I was taught to make options markets can basically be stated as follows:
Note that dividends and short interest or cost to carry are not in that basic equation.
If you master these two, to include interest and dividends you can look at an options quote and know where the "real" market might be. Where those orders get filled will also give information about the crowds position and what way they might tick implied volatility or perhaps what orders they might be aware of or expecting.
The futures market is very liquid but you could "buy the wings" meaning own a long term call and a long term put to protect you against extremes, but options and futures expire so doing the roll every quarter would be a pain in the ass.
Perhaps the naked options would be a lower cost substitute to trading the future?
My gut, though is that you are making the simple more complicated. SPY has deep and active options and SPY does not expire. There is less leverage, so read, less risk. I do not know if SPY trades the mini options contracts where one contract is 10 shares of stock BUT if they do I'd suggest learning with live trades in that market.
If you describe in more detail what you are thinking of I could share opinion on the idea if I thought specific trades might work.
These two books were required reading for me before I went active on a seat. IMO "real trading" is arbitrage or nearly simultaneous closing or hedging transactions. Everything now is directional position trading and it is way way harder to make money. All the best. Dan
Suppose ES has risen 50 points over a 3 days period and I believe 10-20 points drop would occur by the 4th or 5th day. I would enter a short and average up when the price rise against my initial position. There would be a point where I would stop out if the trade is not working out.
I am thinking of using options to -
1. Give me more room/buffer to wait and see if the trade could work out instead of stopping out. So the options should limit the rate of loss once the price rise against certain level.
2. If the price does collapse, the options could potentially add to the profit together with my future shorts
What I am trying to figure out here is if there is a effective way of achieving the above in the time frame (1-2 days) I'm not looking at buying "hedges" to protect a core position over a longer term.
I was thinking along the line of quasi arbitrage or spread but so far I'm inclined to think it is not possible to do it in a cost effective way. I thought it good to ask on this forum and perhaps something which I have not thought of could come up or lead me to some new ideas which I can add to my current trading method.
@jonc It is difficult to understand what you are describing. Are you saying you are short ES and the price has rallied against your short by 50 points and that you expect a 10-20 point reversal, so you would sell more to average your cost higher? You would have to more than double your short deltas and you would still not break even if you closed the position at the bottom of the move.
If this is a hypothetical simply to illustrate the concept, I'd say it is a very unlikely method for sustainable trading. I would suggest that you NEVER attempt this. Be wrong often for a few points, a few ticks even. Let your winners run to 50 handles.
Many retail traders use Average True Range to determine appropriate risk for whatever time frame they are trading. Many guys are comfortable with 2X or 3X the average true range. Some people look at Parabolic Stop and Reverse.
The similar metric that a pro might start with is standard deviation.
My opinion, and it is one that came with a HUGE price over many years. KILL YOUR LOSERS LITTLE! The idea of adding deltas to a loser is something that will probably ruin your chances.
In trading, that is to say short term directional speculation I will NEVER add to a loser. I simply lose. Each day and each week I review with special focus, my worst 20% of trades. The goal is to be reviewing winners among the worst 20%. Yes I have to be more selective. Yes it is difficult to realize a loser. Yes, it is difficult to let winners run. Both of those are paramount to good trading.
Last year (2017) My biggest net trading loser in /ES was 8.5 points. I had over TWO HUNDRED of 4-5 point losers. BUT, I have winning trades in my bottom 20%. You are looking for a way to fight the tape. I fought the tape for years, I bet it cost me over a million dollars.
So, what I'd say if you have to fight the tape. Fight the SPY not the /ES. To be short use the front week or front month long puts. This will cost the least and still allow outsized % gainers when you are right. The options have a finite life, till you start rolling them and the WORST outcome from a long option is that you lose all your premium.
If you cant resist, and I suggest you do resist, you can look to do credit put spreads where you take in premium and have a narrow band of risk well defined by the strike prices in your spread. Ratioed put spreads against a long stock position, can enhance profit with limited risk. Correct to think that more transactions add to cost.
jonc, please reconsider and think very carefully about pressing losers on futures with options.
Dan I appreciate your contribution to this forum. Why someone would want to try to trade arb on a retail platform is beyond me but your explanation is excellent
Volatility is good for the market and trading.
Preservation of capital is the most important concept for those who want to stay in the trading game for the long haul. - Van Tharp
People come in contact with all kinds of ideas, some good some bad. As far as I can tell statistical arbitrage IS perhaps the only viable arb opportunity that can be well executed as a retail account on a retail platform.
Short one long the other of two highly correlated products. For me, to do that in a meaningful way the positions in equities would have to be too big, that is it would take away from other things that I view as higher probability and that I am more comfortable with.
One way that I would look at, and I will when I have time, is to be short put on one (long deltas) and short call (short deltas) on the other. So, collect two premiums, remain kinda delta neutral as opposed to dollar neutral, and have the chance to close the arb if the expected reversion occurred.
I'd think about and build that strategy out with someone if anyone cares.
