My goal has been to build an SPX option structure for less than free to "protect" some short vol structures. I started in October 2021 by selling 6x 2.5 delta 120 day SPX puts. I then place an order to buy back 10 of that same option for less than the initial premium collected. Rinse and repeat by initiating a new short 6x, new 2.5 delta put and the new 120 dte. I've been slowly adding to this (increasing size) over time. The number of puts I'm net long has been growing nicely. I acknowledge that this "strategy" has benefited from a one time, random, possibly permanent impact; a sort of timing luck factor. But clearly, I initiated this and stuck to it systematically during a tough time for short vol strategies and it appears to be robust. I've been net long as many as 78 SPX puts, and am currently only net long 31. I can provide a link to my spreadsheet if there's interest. How am I going to lose? What will the path to destruction look like?
You're starting from scratch and initiating a short position every 120 days; until your second buy order gets filled, you're exposed to a major negative event - the thing you're evaluating as likely enough that you're trying to protect against it. Based on the above, you get filled on those longs 10-20 times per term / every 6 to 12 days; currently, a 120DTE 2.5D in SPX is around the 2800 strike and going for ~$9. That means you have ~$1.7M exposure for 6-12 days, and at least $560k for another 6-12 days (since the 2.5D strike moves up with time.) Of course, this is just theoretical, since the market going to 2800 isn't really on anyone's dance card (except maybe some doom preppers.) It's enough that people are willing to pay $9+ for 4 months of it, but I'd say the risk is pretty low. And yeah, I'd be curious to see your spreadsheet.
If I understand BWS correctly, he's saying there will be a sudden vol regime change (discontinuity) and you'll get caught off guard without having time to buy back the puts. Again, in theory... you may be able to play the game for a pretty long time before getting caught though.
I had the dubious privilege of watching both VIX and SPX during the COVID crash; had the charts and the time/sales tape on the screen along with the short puts that I was in, NUE and CVX, and stayed glued to it all day long. Once vol started accelerating, it was an avalanche: the B/A spreads went straight to hell, there was no liquidity to be had anywhere, and everybody (by extrapolation, but with a good degree of certainty) was Losing Their Shit. A market order would have been sheer suicide, and a limit order wasn't getting filled unless you lifted the offer into the stratosphere. And that was just me - a little 1-10 lot retail guy trying to learn and hoping not to die in the process. The pro guys with thousands of lots out... you could probably hear their assholes snapping shut all the way down in Trenton, tight enough to snip a steel bar in two. Wildest horror movie I've ever watched, without a single chainsaw in sight.
Imagine if they didn't have breakers installed. Prolly would have made 1987 seem like a minor correction.
Quite a few details missing like are the new long positions held to expiry? Average time held to you are able to buy to cover and add longs? Your short vol you said you want to protect against your long puts ie delta relationship. The most obvious spot for blowup is when you first started the system you were only short those otm puts. Would need some more details to give more answers.
I am initiating another short position when the previous "cycle" gets covered. Specifically, one Oct 19 2021, I sold 6 Feb 2850 puts @ 8.4 to open. On Nov 4 2021, I bought that 10x that same line @ 10.00. I was then long 4 puts "for free". So right then I sold 6 of the Feb eom 3150 puts for 9.50. So now I'm net short 2 puts. (long the previous 4 but short then new 6). This is the mechanical structure. I initiated another "cycle" of this process early on. I also increase size by 3 shorts (eventually netting 2 longs) each month. I hold to expiration. I have completed 61 "cycles". The average time to cover the shorts (complete that cycle) has been 28.9 days. I understand the obvious time to blowup was early. As I stated in my post, I am aware that I benefited from a one time, random, possibly permanent impact; a sort of timing luck factor. I'm looking for a path to destruction. Here's a link to the spreadsheet that tracks progression. Put Factory.xlsx
I want to use this structure to protect some other short vol structures. Yes delta, but I'm more concerned with vega, especially in the tail. My other structures are not net short puts.
I was trading my short vol strategy at that time. The topic of this thread is my attempt at addressing that risk. Probably fighting the last war though.