Covering up your butt-crack

Discussion in 'Options' started by ExchangeRider, Mar 30, 2012.

  1. Is it just me or does the TLJ (double diagonal ratio spread) risk graph look like a...

    Nevermind that. I am interested in using options to create an IV hedge for a combination of TLJ trades. Since IV is this trade's primary risk, I am hoping to use VXX or VXN to control and perhaps even mitigate IV risk while still allowing me to keep the trades with their explosion positions on the table.

    I have been searching for some kind of IV correlation tool that would calculate my portfolio's vega to VXX correlation value for the purpose of constructing a more precise IV hedge.

    Does anyone know if such a tool exists or if there might be an alternative solution?
  2. newwurldmn


    What is TLJ?
  3. I think it is an Optionetics term for the double diagonal ratio spread. They call it the Tarzan Loves Jane trade.

    This is the risk graph. The trade has a very high vega so it is ideal for situations when you expect a surge in IV. The whole risk graph in this picture can shift to the right dramatically with an increase in IV. I would like to hedge these more precisely using some sort of IV correlation tool.

  4. spindr0


    Like most vendors looking for site/seminar subscriptions, Optionetics glamorizes the performance of a strategy and minimizes the risk. I particularly like the way they make up their own names for existing strategies :D

    TLJ looks attractive because of its relatively low risk risk as well as reward potential due to IV expansion and/or a large move. In reality, those wings can require a 15-25% move to become profitable, more if IV decreases and time erodes your excess long legs, and even more if your long leg goes out an few add'l months.

    IMO, to succeed with TLJ, you're going to have to find skew situations and/or successfully predict large moves and/or successfully predict IV expansion. With time working against you, getting some of these right may get you nowhere if you get one of them very wrong.

    Correlating TLJ with a VIX strategy complicates things even more because your hedge may do nothing for you in an up market (IV tends to expand with downside fear).

    I used to these for EA's but good set ups take a lot of work to find and require some agility to maximize the return the next AM.
  5. Yes, this is good for very low IV and skew situations.

    Thanks for the point about IV in an up market. It seems this is usually true for paper assets, but with commodities it looks like it can be a bit different. Take SCO for example.

    I don't ever plan to hold these through earnings, but with an increase in IV, they can be a way to fund one of the long legs through the earnings IV crush.

    The wings of this trade aren't really THAT attractive to me, but they are an added bonus. I understand that there really isn't a way to perfectly hedge a basket full of these trades using a simple correlated hedge, but I am looking for some way to more accurately measure average IV correlation.

    Even if it doesn't work perfectly in this situation, I think it would be a very handy tool to have.
  6. spindr0


    I have minimal experience with commodities so I can't speak to that. If the IV of SCO et al expand during up moves as well, your correlation hedging concept may be more viable. I'd be surprised if you found it but you'll never know unless you look. :)

    IMO, EA's are a good place to utilize TLJ because the IV behavior is predictable, at least to the extent that it's going to collapse. How far and how fast is the art (the guesstimate). That collapse is going to fund your long legs, particularly well if the skew is significant.

    In general, I think these to begin to look attractive when the near month skew is 15+ BP's higher than the 2nd month but their degree of attractiveness also depends on strike width and time until expiration. More practically, if the profit peak of the central peak of the W is 2x that of the W's troughs, it's attractive.

    And due to the disparate nature of nature of put and call behavior, I have found that the ratio needs to be a tad higher on the put side in order to balance the risk graph (that nice even double sided shape of the W).

    Another characteristic of the TLJ EA play is that 2nd month IV tends not to crater as fast as near month at the open. Therefore, many positions that show close to close loss are actually nicely profitable early in the AM. If the UL moves, closing the long leg on the losing side of the strangle salvages more (close that side's entire spread if you fear nekkidness).

    Although seemingly counterintuitive, REVERSE ratioed TLJs can be interesting during the last week before expiry when the 2nd month's IV is also elevated and expected w/o a load of skew.
  7. This "buttcrack" trade is just a slight variation of a calendar. A double diagonal/ Tarzan does Jane trade etc is just two calendar spreads..

    Could someone explain why this would be different/better/inferior to a calendar?

    I mean the idea's exactly the same in both- you need IV to rise...
  8. spindr0


    Au contraire mon frere...

    What happens to these if price moves far away from the center?
  9. The primary difference is you are buying twice as many long contracts further out compared to what you are selling closer to the money, thus the ratio. You can produce similar results by combining say a 10 lot calendar with a 1 lot straddle, which can be a way to transfer directional risk to vega, but the TLJ will still have a much larger vega.

    The correlation idea came up when I was thinking about a combination of TLJ trades, but of course it can be applied to any portfolio that intends to incorporate VIX hedging. I imagine that we could just come up with a VIX to S&P correlation value and then combine it with our portfolio/S&P correlation value.

    Thanks for the comments. I will continue to search around for more info on VIX hedging.
  10. I just thought it was a regular double diagonal. Hence why I thought it's like a calendar. I should have read that posted risk graph better.

    The catch is that it has those extra long wings(especially a bit more on the puts)

    Interesting set up but boy is it expensive on the commissions..

    I can presume its one hell of a position to manage too...
    #10     Apr 2, 2012