A long Vega trade in OEX

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.

7 Responses to A long Vega trade in OEX

  1. I’m somewhat new to options so this may be obvious,but I was wondering why you wouldn’t buy a straddle in this instance. It seems like it would exhibit the same risk characteristics, with the exception of not capping downside gains, and be far cheaper to put on.

    • There are many differences in those two trades.
      * My trade is long Theta on the downside, straddle is always short theta.
      My trade is less long vega such that there’s less losses to the upside.
      My Trade has a much higher breakeven on the downside and around the same breakeven on the upside (excluding vega as above)
      * My trade is buying IV of 25% and 29% and selling IV of 25% and 36%, Equivalent straddle is buying IV of 39%.

      The above reasons are all positive for my trade vs. the long straddle. The two starred ones are big reasons.

      Thanks for reading and commenting. Lawrence

  2. I said it might be obvious! After reading your reply I went back to the TOS analyze page to dig a bit deeper. I definitely see what you mean. I appreciate the reply and have learned a great deal from reading your blog. Have a great weekend.

    • I’m glad I could help in your learning, that’s my purpose of writing. Have a great holiday weekend.


  3. Thank you for your interesting post. It helps in learning new things. I am just wondering why wouldn’t you do a backspread (-10 425 Call/ +20 475 calls, Aug). The cost will be much cheaper and reward probably being higher (let say aug expiration at 420..) Thanks for sharing your thoughts.

    • I’m away from my computer for a few days. When I return I will give you a better analysis but the first reason is by buying Sep and selling Aug I take advantage of the favorable horizontal skew vs the backspread with all Aug options.

  4. Thank you. Yes, I would appreciate your perspective about the difference. From what I see in my TOS account, your spread will cost about 12,000 in margin, Position Vega is 81, delta is 12.6 and theta is -17.6. There isn’t much of horizontal skew if you use ATM IV as a measure. The skew between 470/425 is largely due to OOM. Also if Sept IV drops while Aug remains same, then the risk to position is higher (or vice versa).

    While for backspread- It is pretty delta neutral, theta is -18.5, vega is 83 and cost is about 2,700.

    There is some P&L difference though but when normalized on cost, I think it comes out to be better.

    Thank you for your sharing. I appreciate it.

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