Skip strike unbalanced butterfly spread in EXC

Posted by: Admin: "The Vol_Trader"  //  Category: Volatility Trades

Sorry for my absence lately.  I’ve been consumed with starting two new small businesses.(Not trading related.)

Today, I’m back with an interesting trade I will call an ‘unbalanced or ratio skip strike butterfly spread’.

The trade is in EXC. My trade logic is:

EXC announced earnings that disappointed.  The stock went down and has continued it’s downward move for the subsequent two sessions. (Trade was placed yesterday 10/26/2010 and it’s down again today as of this writing).  The daily chart is below: (click any picture to enlarge)


You can see a clearly bearish trend over the past year.  The recent down move has broken down below support since mid Sep. 

Interestingly, IV did not move up with this large point decline.  The below six month chart of 30 and 90 day volatility (source: Live Vol Pro) shows that IV only moved up slightly into earnings and was (and still is) well below the historic implied volatility for the past six months.


Below you can see the recent large move down without a corresponding pop in 30 and 90 day implied volatility.


With all of this info I’m predicting a further move to the downside in EXC and an increase in implied volatility over the next 90 days.

The trade: +10 Jan $47.50 puts / –30 Jan $44 puts / +40 Jan $39 puts

The profit and loss chart look like this (Source Think or Swim):


EXC is currently trading at $40.60 as of this writing.  At expiration this trade is profitable above $41.86 and below $36.15. 

Below you can see the chart of vega vs. underlying price.  The trade is very long vega at the money and down to $36ish.  It is short vega above $44.


As I always say, I’m entering trades like this to take advantage of the implied volatility in addition to picking direction.  If the underlying moves up and I was wrong I will become long theta and can wait for decay to work in my favor or get out with a small loss.

If the underlying moves down quickly I’ll profit from my short delta (direction) and from my long vega as implied volatility increases.  This is the result I’m looking for.

My risk in this trade is a slow move to the downside with decreasing implied volatility.  My risk is defined to a maximum at $39 at expiration.  Luckily, markets tend to move down quickly and up slowly. 

Exit plan:  I’m hoping to get a quick downside move prior to expiration and take profits.  An explosive move to the downside would work very well.  If I am given a profit I will sell off a few contracts at a time taking profits.  If the underlying moves up I will likely take a small loss to a small profit depending on what volatility does.  Since it is already low on the charts the volatility may not drop much and I’ll have a small profit.

Thanks for reading. Please send comments.  I have some comments from my last post that I’ll address in the next few days.  Again, sorry for my absence…. – Lawrence

An update on V and ASML trades:

Posted by: Admin: "The Vol_Trader"  //  Category: Trade strategy, Volatility Trades

Sorry for my absence lately.

After Jul expiration I wanted to update you on two trades, V (Visa) and ASML. 

V update:  This trade turned out to be a good example of my management and trade adjustments that I regularly do, and ended with a little good old fashioned luck…

As you know, this trade was placed on 5/21/10 with a bearish bias (Click here to see). 

image Four days after I put the trade on, I took off 3 of the 10 contracts for a small profit.  Often, if the trade goes well right away, I’ll take off a small portion for a quick profit and let the rest go for additional profits.  In mid June V went up and I had an unrealized loss with Jun expiration approaching.  6/14/10 produced a nice down day and although I was still at an unrealized loss, I was able to take advantage of the down day to produce a favorable roll, buying back my short Jun options and selling up and out Jul options. (Click here to see roll) Immediately after this, V rallied and then dropped back.  On the drop back, I was about breaking even and I decided to let this trade continue expecting a further drop in V and the market in general.  I was wrong and the market and V had a strong rally into Jul expiration week. I like to roll my shorts by Tues prior to expiration.  I analyzed rolling my short Jul options out to Aug or up and out to Aug but nothing looked good to me.  At best I would have locked in a smaller loss than I currently had.  My two choices were to close for a loss or hold on a few more days hoping to get lucky with a drop into expiration as my trade was purely a directional gamma play now.  Normally I would not hold a trade and hope for a lucky ending but in this case I didn’t see much risk to the upside and my alternatives were not good as I described above.  Additionally, since I was able to take some profits on the first three contracts, I had a little bit of a buffer.  Well, I got my wish and expiration Friday turned out to be a great day.  Right at the open I took off five of the remaining seven contract spreads for a nice profit, and later in the day, I took off the remaining two spreads for an even larger profit.  In total, I ended up with a $1,442 profit. 


ASML update: I’ll jump the conclusion and then tell you how I got there.  As of Friday’s close I’m down $246 on this trade.  This is not bad considering that this trade is bearish and long Vega.  I put this trade on with ASML at $30.28.  Friday ASML closed at $30.92.  Clearly my short delta didn’t help this trade.  When I put on the trade I was long Vega and this trade remained long Vega throughout the whole time.  Implied volatility dropped from 42.38% when I placed the trade to 36.08% at Friday’s close.  So how did I (about) break even when delta and vega moved against me?  A few things helped.

  • First and most important, SKEW.  Click here to see my initial post where I described putting on trades that have ‘a slight advantage based on volatility’ skew.  By selling higher Vol options and buying lower Vol options, when the skew reverts you benefit. 
  • Second, trade management:  I took some early profits similar to the V trade.  (Click here) Note: the long calls I bought as cheap protection ended up worthless.  Had the underlying moved up a lot more they would have come into play, but the small rally didn’t affect them.  I lost a small amount on them.
  • Third and final reason, time decay.  I almost always like to start with time decay working in my favor, negative gamma trading.

Just like the V trade, I had considered rolling my short Jul options to Aug but again there was no favorable roll and I would have locked in a small loss at best.  I decided to close the trade for a small loss on expiration day.  As most of you know, trading a liquid underlying’s options on expiration day it is difficult to get advantageous pricing as the market makers (and their computers) know you need to get out.  In ASML case, it’s not so liquid so that makes it virtually impossible to get out with good pricing on expiration day.  With that said, I’m currently long Sep puts naked as my short Jul I closed for $0.05 (Commission free to close short $0.05 options, thanks Tom at Thinkorswim) and I couldn’t sell my long Sep puts for a price I wanted. I now have upside risk.  I’ll close these remaining Sep puts at the open Monday unless ASML is going down, then I’ll monitor them and perhaps get lucky again. 

Note, these are not trade recommendations, click for legal disclaimer.

A long Vega trade in OEX

Posted by: Admin: "The Vol_Trader"  //  Category: Trade strategy, Volatility Trades

It’s rare that I am completely or mostly ‘out of the market’ but this is one of those times.  I tend to travel a lot in the summer and when the market cooperates I like to take profits and leave the city with small to no positions on to worry about.  On vacation I like to log on to Thinkorswim no more than once or twice a day.  With the recent downturn in the markets I have done very well and took off lots of profits…

However, going into the Independence day holiday vacation for a week, I can’t resist having some short delta trade on.  I really think we are going to give back a few more months of gains from the previous year long rally.  As my friends and readers know I never believed in the rally from March 2009. 

So, I want a low maintenance trade that I can look at once or twice a day on vacation that requires little to no work.   I would have liked it to be Theta positive but it starts off short Theta. 

Trade logic:

  • I want to be short delta but have protection to the upside. 
  • I want to be long Vega but not get hurt too badly if the market goes up and IV drops.
  • I want to have a limited risk trade.

I like trading the OEX.  I get good fills, often better than theoretical prices.  It has good liquidity with 100’s to 1000’s of contracts of open interest.  It requires 1/10th as many contracts as SPY (hence 1/10th the commission, sorry Tom Sosnoff).

Here’s the trade:

First I put on an Aug / Sep $425 / $470 put diagonal.  (+10 Sep $470 puts / –10 Aug $425 puts).  This gets me long Vega and short Delta with a small positive Theta.  It has limited losses to the upside but is sensitive to a drop in IV.  It looks like this: (Click any picture to enlarge)


Next, I put on an Aug / Sep $475 / $480 ratio call reverse diagonal. (+10 Aug $475 calls / –5 Sep $480 calls).  This gets me long delta and long Vega and is short Theta.  Being long vega is a double edge sword here.  If the market moves in the desired direction, down, the long Vega will make this hedge lose less, but it also makes it a less hedge than it first appears.  However, it is very long delta so that lessens the long Vega losses on the upside.  On the downside it has limited losses and becomes more of a long vega play than long delta. This part of the trade looks like this:


The combined trade looks like this:


I like to use diagonal spreads more than calendars.  I often find that I’ll put on an OTM put calendar and I’m correct and the underlying moves down very quickly.  When a calendar moves too quickly you don’t make anywhere near maximum profit.  For a calendar to make (near) max profit the underlying needs to be at the short strike at expiration week, not right away.  With the diagonal spread there isn’t that change in delta after you cross past the short strike price. 

I also like the above ‘ratio call reverse diagonal’.  It’s positive delta outweighs the long vega on the way up and as time goes on, it becomes less long vega and if the underlying moves down the long vega offsets some of the short delta. 

Exit strategy: Obviously I would not hold this trade past the Aug expiration despite owning Sep options.  I’ll look to take profit or small losses if the underlying moves up quickly.  I’ll also take small losses if it stays in a tight range and suffer from the short theta.  If if moves down past $450, I’ll start taking off one or a few contracts at at time to lock in some profit but I will not be in a rush to do so b/c I’ll be long theta at that time and presumably benefitting from my long vega.

Have a nice Independence day, and hopefully enjoy your long holiday theta!

* Not a trade recommendation for education only. Legal Disclaimer, click here.

ASML – ASML holding NV ADS – Trading Horizontal Skew

Posted by: Admin: "The Vol_Trader"  //  Category: Volatility Trades

As you have probably already have seen in my trade postings (for educational purposes only, not trade recommendations) that I like to try to start every trade with a slight advantage based on Volatility.  I always like to try to sell higher Vol options and buy lower Vol options to hedge.

Today, I ‘m trading horizontal skew (from month to month) .

I used LiveVol Pro scanner to find “High Put Volume”.  I found ASML.

Below is the LiveVol skew chart: (click any picture to enlarge)


The trade: –24 Jul $27.50 puts, –12 Jul $30 puts, +24 Oct $30 puts, +12 Oct $35 puts.

Originally I had modeled and considered the Jul / Oct $27.50, $30 put diagonal but it was Short theta from the start and I wanted a little more upside cushion so I added the $30 / $35 diagonal to move the breakeven up a little more.

You clearly see I’m buying much lower IV in Oct and selling higher in Jul. I’m selling 47% and 42% IV and buying 38% and %35.

I’m short delta, short gamma, long theta, short Jul Vega, Long Oct Vega.

The Thinkorswim analyze tab looks like this:


ASML closed today at $31.01.  I managed to buy my short delta trade near the low of the day unfortunately. 

As the underlying went up, Jul IV came down relative to Oct.  The trade is already losing but not as much as the model had predicted due to this. 

Exit strategy: I’m keeping the $32 level in mind for my mental stop price.  At Current IV that equates to around $1,500 loss.  I’ll start taking off contracts for profit at around $29.  As usual, I’ll take off small amounts of spreads at a time as the underlying moves down.  As long as the underlying is below $32ish, I’m positive theta and am in no rush to sell.

I’ll update this trade as it plays out. 

V – update – trade management, a favorable roll

Posted by: Admin: "The Vol_Trader"  //  Category: Volatility Trades

As you know from my previous post and update on the V trade (Click here to see), we’ve taken off 3 of the 10 contracts for a profit. 

Since then, the underlying has moved up and away from our profit zone.  (Trade was entered with V at $74.20 on 5/21/2010 and moved as high as $77.49 on 6/10/2010.

Yesterday I rolled the remaining 7 short Jun $65 puts up and out to the Jul $70 puts for a credit of $1.67 (Bought back the Jun $65 puts for $0.07 and sold the Jul $70 puts for $1.60). This moves my upside breakeven price up to around $72.95 at current IV’s.  V is currently trading above that at $74.64 as I write.

Below is the current Thinkorswim analyze tab after the roll. (Click to enlarge)


As when I initiated the trade, I’ll keep $80ish as my mental stop.

This is a good example of a favorable roll at expiration week.  I was able to buy back my short puts for $0.07 and stay in this trade a bit longer.  Since I’m long the Sep expiry, theoretically, I can roll to short August puts as well in the future.  Had I lost faith in my bearish opinion on V, I would have taken the loss and closed the trade.  I’m still convinced that there is downside potential here.  By performing this roll, I stay in the trade.  By moving the short strike up by $5, I’m able to increase my chance of profiting as well compared to rolling to the same $65 Jul strike.