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

VIX update

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

In my may 5th blog post I commented that the VIX had run up much faster and higher from 27-Apr to 5-May than it did when we had a market correction in Jan-Feb which was actually more severe at that time. 

Well, I spoke too soon about the ‘severe’ part.  If you read that post you saw I was trying to come up with ideas as to why the VIX behaved this way.  Had I put a #5 bullet saying, “tomorrow will be a historic down day”, I would have been a genius (and very rich). 

Conspiracy theorists would say that the GS’s of the world were buying SPX puts the day before the ‘crash’ driving up the IV.  

Moving forward, My 06-May post and 13-May posts both discussed me getting long Vega and short delta.  Boy was I right on both occasions.  06-May was a nice day to be long vega, short delta into the crash.  I took some nice profits then.  13-May turned out to be a great day to get long Vega, short delta in the AM, and it continued Friday, 14-May leading to my best ever two day streak. 

You can see the action in the SPX and VIX here in the LiveVol Pro software.  In the below chart the first candle is 23-Apr-2010.  The recent high is the next day 26-Apr.  The bottom line chart is the 30 day IV. 


You can see the IV went up and stayed pretty high and curved up Friday, the last candle.

Below is the LiveVol Pro chart of the VIX for the same time period:


At the end of the day Friday ,15:45 EST, I decided that I didn’t want to carry my very short delta risk into the weekend.  I sold a lot of (expensive) Jun OEX $510 ATM puts to get less short delta and shorter vega.  Looking at the Thinkorswim SPX chart below, you can see I was not the only one getting less short / long at the close… from 15:30 to 16:00 the SPX rallied  +$9.11 from a low of $1126.57 to close at $1135.68. 


NOTE: Check out the LiveVol Pro software at:   I  just love it so much that I couldn’t trade without it anymore. 

Hopefully next week, I’ll find some time to post some individual equity trades again.  Please stay tuned! Thanks for reading Vol Trader Blog!


I need more + Vega …

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

I currently own off center short index strangles.  (Short puts and call skewed to the downside. This makes me short Vega and short delta). These do well if the market stays the same or goes down slowly.  In the recent correction IV has spiked and remained high.  My short delta has offset the short Vega, but I’m missing out on the ‘bang for the buck’.

How do I get short delta and long Vega without buying puts that decay and lose quickly if the market goes back up and in return IV drops?

One way is if I offset the long puts’  negative theta and make Vega work in my favor by trading a COMBO, long put, short call.  Picking the strikes is the hard part here.  I usually look for support and resistance above and below the market. 

Note: I’m not recommending COMBO’s as a stand alone trade, but rather a way to achieve the above goals when managing a portfolio of option greeks.

In this case I have a significantly large inventory of short OEX puts and calls. Today I chose the following trade: long Jun $475 puts, and short Jun $560 calls.

The P&L looks like this below (click any picture to enlarge):


The white line is today and you see it behaves like a synthetic short but the strikes are different.  For this to profit you want the market to move down and do so right away if possible. 

Where this trade gets much more interesting (at least if you’re big geek like me) is when you look at the curve of Vega vs. underlying price:


As you know, when the underlying goes up IV drops, and when the market goes down, IV increases.  Look at that beautiful curve above.  As the underlying moves up from the current price Vega is negative, and conversely as the underlying moves down from the current price Vega is positive. 

In summary, adding this combo to my current position allows me to benefit on the way down and hurt less on the way up.

Testing, testing, 123

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

Sorry for the corny title, but I’m testing a strategy in my Thinkorswim paper-money account. I’d love some feedback and discussion of my trade logic, so please comment!

My idea is as follows:  I want to get short delta and long vega for what I think is the inevitable market crash that is coming. I’ve been saying this since the short term correction in mid July 2009, so please do not let my idea influence any of your trading decisions.  Let this be a lesson in the greeks, rather than market direction.

So, short delta and long vega, what is the first thing that comes to mind?  If you said a long put, you be correct.  The problem with naked long puts is time decay works against you.  You can only be right if the market moves down and does so right away.  If it goes down slowly you lose.  If it stays the same you lose.  If it goes up you definitely lose quickly, not only from delta but also from Vega as IV generally goes down with market rallies. 

I want to get long vega and short delta by purchasing puts.  I chose to buy OTM Jun 115 puts for $1.55 with SPY trading at $120.16, 50 contracts.  (The simple facts: These are .25 delta, so they have a close to 25% chance of expiring $0.01 ITM which of course means I lose the full $1.55.  In order to break even I need them to be $1.55 ITM or SPY at $113.45.  Any lower than that is profit.)

This is what the naked long Jun $115 put looks like at May Expiration below in the Thinkorswim analyze tab. (Not Jun Expiration, I’m going to add May options to this trade and the plan is to be out by May expiration.) At May expiration and at the current price and IV the max loss is around $7,700, and breakeven is around $117.


In order to offset theta, I decided to sell a Jun ATM 120 Straddle 25 times. Adding the straddle actually makes the theta slightly positive (close to zero) at the current price. The naked long put has a negative theta of around $150 / day.  Now, combined long put, short twice as many straddles leaves me with risk to the upside because I’m short naked calls from the straddle.  The short puts from the straddle ore more than hedged due to twice as many long puts.  The comparison of the two trades are below.


You can see the naked put does better if the market falls below $115 but the combined trade does better up to around $125 but this chart is not showing something, the effect of vega. 

Below is a chart of Vega on the Y axis and underlying price on the X axis.  The combined position clearly has an advantage to the upside.  It is short vega above $117.50 whereas the long put is always long vega.  Remember, as the market goes up IV generally goes down. 


The last adjustment is to address the upside risk.  I’m net short 25 June calls.  To offset this I will buy 25 May OTM $123 calls for $0.68. Call these the cost of insurance.

Now, I have less risk to the upside than just the naked long put.  In the below chart you can see the combined position has a max loss at current IV of around $4,400. I sacrifice downside profit, but I significantly reduce risk.  Plus, If the market crashes I will be long Vega and should do really well to the downside.


Below is a year to date chart of SPY on the top and 30 IV on the bottom from LiveVol Pro.  You can see IV is at a low of 13.81% right now.  If we have a major pull back to where we were on 2/5/2010 you can assume IV will be at least the same, but probably much higher than 23.77% that it was then.  this 10% increase translates to $1,200 profit on the combined position with Vega currently at $120. Remember from the chart of Vega, Vega increases as SPY drops too, so the profit from Vega should be much higher.


After all this, I’m considering putting this position on in real money tomorrow in a much smaller quantity…

Remember, nothing on Voltraderblog is a trade recommendation but just an educational forum…

Bonus: Why does IV go up as the market go down and IV go down as the market goes up?  — When the market goes down longs buy puts for protection.  Remember option pricing is controlled by supply and demand. Demand goes up and the market makers having to take on more risk being short options increase prices of puts.  The only variable that is unknown in option pricing formulas is IV, therefore, as option price goes up, IV has to go up as well working backwards from option pricing formulas.