I have never traded options. I understand the general theory but not how to put that into practice. I have created an algorithm that trades the VIX ETF's with good success. However, due to the leverage I am using, a huge overnight jump in the VIX could wipe me out and I need to protect myself against that possibility. I can tolerate a sudden (as in overnight) 30% drop in XIV. According to my calculations, this approximately corresponds to a 50% rise in the VIX, or a 5% drop in the SPX. What would be the best options to purchase in order to limit my loss to the values listed above? I am thinking that it would involve buying weekly SPX puts but I'm not exactly sure how to systematically do that. Thanks, Steve
Deep otm ratio put back spreads in es .. or otm vix calls... Either way it sounds like your just shorting premium.. there is a bunch of ways to do it.. but using vix etfs is just another way
Algo 52: Some thoughts, without providing the specific answer your question (which options to limit loss). Curious why you chose XIV over SVXY which is basically a 2X of XIV (2x leverage, since your leveraging already). SVXY, unlike XIV, also trades options (however, not as liquid as we would prefer); Both are fine instruments, just curious. Do you understand how XIV and SVXY are constructed and what makes them move? If not, this may aid in you understanding where you may get the most bang for your buck on loss limitations. Both are short front and back month VX futures, so the VIX pop (both front and back month VX futures will increase) is the cause of the drop, which can be massive. A generic approach to your quest could be just "money management", control the size of the position and take money off the table when appropriate. Curious on qty trades / year for this. Count on one hand, or over 20?
A 2x fund doesn't do as well as an equivalent $ amount of XIV and an equivalent amount of short VXX. I do understand the workings of these instruments and "taking money off the table" doesn't help. I am trying to guard against the "two airplanes crash into the world trade towers" type of scenario. Completely unpredictable. A huge hit to the average investor. A complete wipe-out for me.
cdcaveman: Thanks for your suggestion. I am completely clueless on how to use options. What would be the advantage of the put back spread strategy vs. just buying OTM puts? I want to do this as simply and cheaply as possible. So in my mind I was thinking that I'd want no payout until I reached my loss threshold. In any decline past my loss threshold the option payout would offset the loss to my XIV and short VXX portfolio. Thanks, Steve
Just thinking out loud... If you are able to quantify a fairly precise point, at which you want the protection to begin to kick in; And determine the amount of constant drag you can afford to provide it --- using cdcaveman's response, you should be able to construct something. -- He probably has more experience with these than do I.
Algo52: Looking at your statement, I observe this: >>I want to do this as simply and cheaply as possible. So in my mind I was thinking that I'd want no payout until I reached my loss threshold. In any decline past my loss threshold the option payout would offset the loss to my XIV and short VXX portfolio.<< If I understand that correctly, would the following not be an optimal fit? (without the normal drag of an option position) When max loss threshold touched, Buy (either front or back month) VX Futures with size equivalent to offset your position. this should offset further losses. This could give you some time, to decide if you want to really exit or not, as it freezes your PnL. Plus you can do that with the futures trading hours. This is actually is similar to exiting at your max loss except for GAPs and additional slippage. This does not employ options. Regarding a back-ratio, VS just buying an OTM PUT...: The short OTM PUT can be used to help finance the trade and move the break-even point higher.
For the back spreads, are you doing it for breakeven or a small debit? Are you looking at selling the 7-10 delta and buying two of the 3-5 delta puts?
- can you give a little context on how you trade? pair trading or long XIV / VXX only or .. ? - do you need to trade exclusively on XIV and VXX? can you modify it to SVXY and VXX? since they both have liquid options (you can build strategies around it) - to limit losses from a big gap when the market is closed.. have you considered using VX futures? - to limit losses from a big gap on trading hour.. have you considered to simply close the trade? be careful not to add new risks into a losing position by using options
Can you close your positions at the end of every day? You can't get wiped overnight if your money is sitting comfortably in your sweep account.