I'm new to trading the skew. Each morning I compile a list of options with attractive skews based on closing prices. I often find great calendar spreads and backspreads. But when I go to trade them, the prices have changed dramatically. It seems that most skews don't even last overnight. The market makers are opening at prices that eliminate the skew. How does somebody find a skew that will last long enough to set up a trade?
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Closing prices can be very deceptive--why ???? sometimes the last time an option traded was with an hour left in the trading day, and the stock may rally/sell-off in the last hour without the option trading, and then you have the old/stale price being used for that days settlement. Second, eventhough the bid/ask spreads have tightened significantly in the last few years, you still may have a situation where you are looking at one option that settled on the bid, while the other settled on the offer--which may lead you to believe that there is more edge in a certain spread that there really is. And last, keep in mind the decay that takes place overnight. Options at-the-money will decay faster than those out-of-the-money (in the same month)due to their higher premiums (and also keep in mind options with closer expirations will decay more than those farther out in date), so if you're looking to sell ATM and buy OTM based on yesterday's closing prices, you will find that the price you can sell the ATM this morning is less that you thought, while the price of the OTM you wanted to buy is lower also but not by the same amount as the ATM you wanted to sell, removing some of the edge from the trade. Hope this helps, and welcome to the world of options. Vega
Sounds like you are trading the McMillan method. I went to his talk at the Chicago Expo that is why I am guessing what/how you are trying to trade. From what I understand, he used the bid/ask to calculate the implieds. Also notice that in the mornings, the options don't start trading until about 10 minutes after the equities have opened. nitro
Nitro, you are exactly right. McMillan is a respected name and I've done well following his straddles, but I'm beginning to feel that his calendar spread list is just "window dressing". I can't find a trade in the whole list. How did you get around this?
Adam, I wish I could be of more help. I am a newbie at it myself. As I educate more on it, I will try and share what I have learned. The first step that I have taken is to get a free trial to Realtick. I will be following the step by step procedures that he outlined in his talk. He is e-mailing me the notes from the talk so that I can go over it a step at a time. I also went to his website and I was astonished at how many of the stocks/indeces, based on his calculations, are at the "Zero'th percentile Implied Volatility," e.g., IBM. Remeber, he uses Black Scholes as his model, and that can lead to some anomalies in certain cases. I am developing my own model that I am hopeful will lead to better approximation to implied volatilities and a more accurate picture of the skews.... I wish I could offer more... nitro
If it was easy, everyone would be doing it and those making markets would quickly be out of business. Note that you are a newbie. Perhaps thousands of others are looking for skew trades as well. The trades you are seeking may be out there but others are beating you to the trades. Looking at overnight closing data may be a great educational tool, but it is unlikely that an arb or what looks to be a juicy trade that may exist on closing prices will exist on the open.
prices get marked on the close on just about every strike in play which are the ones your probably watching backspreads are a great way to get your feet wet, but dont fool yourself and make sure until you know what your doing, you know how to spread that puppy into a fly on the run. trade note options, you will like the liquidity short vega and scalp gamma against your position, time almost always beats movement