spindr0, Magnitude of the daily ROC is relative as an entry would only be considered when the spread is in a statistically abnormal state, lets just say with a probability of 5% or less of occurrence. The daily trading pattern is already sorted out as this is just a matter of creating a spreadsheet that compares price % changes in both indices (the spread) over various time frames and then performs standard deviation calulations. All of my data is based on a day to day basis as opposed to intraday as I am a position trader. You hit the nail on the head when you said that determining the value of each index (or any financial instrument for that matter) is subjective. I wish to avoid any such wasted effort and focus solely on the spread, if possible. I know this goes against the grain of typical pairs trading. I am very comfortable with regression to the mean and when I establish positions such as the one we are discussing, I enter it in small quantities and build it over time. I have enjoyed consistent success with small drawdowns in this manner. However, entries come along rarely due to the requirements for the "exagerration" of the underlying, and so when I enter, regression to the mean occurs quite rapidly. Thanks.
While an offer of assistance from Bob or anyone else is appreciated, I am not sure how this topic turned to this unrelated subject matter. I never expressed an interest prop shops or in shopping this concept around as an HFT. Thanks.
Roreilly. My intention is to isolate and capitalize upon the time decay while remaining as directionally neutral as possible. Exceedingly high volatility for both indices at the time of entry will be present, so there is a high probability that volatility will fall after entry. Bull Call spreads have no appeal in this case because they are net long and therefore suffer from time decay. However, bear call spreads will be a candidate I research. Your second suggestion of buy/writes is also worth consideration, although, like you said, it is capital intensive. Thanks!
hello hfstartup, thank you for your reply to my reply i should clarify regarding a +theta trade and its importance. with my limited experience, i will say, that neutralizing vega and gamma (or+) and having a flat delta position upon trade set up, even if you initially have a -theta at the start, the theta will take care of itself. that is where i'm coming from when i say that theta comes in last place because if the trade is structured properly, it will make money which is the bottom line. i understand this could be off topic but perhaps on another thread. good luck. dave
Thanks to everyone who has posted their thoughts and suggestions. It has made me consider a number of issues and I am now formulating/refining a structure for trading the inverse indices. The question I have is whether it is optimal given the conditions and desired outcome... For clarity, I will restate the revised purpose: To enter into a trade when the spread (the sum of the % price move differences of the two indices) between two almost perfectly inversely correlated indices is stretched to a statistical significant (and rare) level using options so as to be able to utilize time decay (suggesting that the strategy must be a net seller of options) and in an environment where the heightened volatility of the downward moving index and the substantially lowered volatility of the upward moving index is maximized in a directionless/neutral manner. The trade is intended to be closed out when volatility levels reverse and time decay has whittled down premiums. Given these conditions and the comments posted, I find my attention being drawn to straddles. To be specific, selling a straddle on the declining index and buying a straddle on the inclining index. I would do this in a ratio, perhaps selling twice as many options as I would buy if needed to produce a net credit. The net short aspect of this strategy (if it exists) would allow me to take advantage of the time decay, provide a method to capitailize from the statistical fact that markets tend to decline faster than they rise, and provide some degree of hedging. Some concerns do come to mind with such a strategy such as the cost of the options I sell versus the cost of the options I buy, which would need to be a net credit to make me a seller and benefit from time decay. Logically, I would assume that the options I sell will be at much higher premiums than those I buy since their volatility is increasing and the other's is decreasing. However, this isn't always the case since it will depend more on IV (anticipated volatility) rather than historical volatility. I am concerned that any ratio other than 1:1 creates a directional bias, but how much of an impact it will have is yet to be determined. It is a fairly simple strategy, made even easier since it is vertical. Thanks again for those who contributed and I welcome any further thoughts. Thanks.
DaveyC, Thank you for your reply to my reply to your reply! Your clarification makes much more sense. Delta neutral trading as you are describing has always been a secondary concern for me since I manage a portfolio and seek to build up an inventory of the underlying while benefiting from the erosion of Theta. However, I recognize that other greeks such as delta and vega are very important to many traders and dependent upon the overall strategy being used. Since all greeks are tied together, I suppose I inadvertantly utilize them all concurrently. You hit the nail on the head when you wrote that "if the trade is structured properly, it will make money which is the bottom line." Thanks again for your insightful comment and I wish you all the best in your trading!
hfstartup, i can't top the thank you to the thank you's but thank you haha. i'm glad you see the clarification and even though i am just beginning to see the light and come out the other side of actually winning trades with help after giving up for a while. the +theta trades like the iron condors or short vega trades that are so popular yet have been killing traders for years now (including myself) fail to understand the real risks involved and can keep a trader up all night, been there and was totally clueless. so this is why my focus is rather on vega and gamma. i understand i got off topic of a trade design for your inverse etf's but thought it could add some value to this thread. all the best, dave
I think that offsetting covered call (or equiv NP's) would be a dangerous way to approach this because in a successful two component regression position, one covered call has limited profit while the other large loss potential. Not a recipe for success. IOW, the profit on the side that woks is limited by the short call but the loss on the side that doesn't work is only hedged by the amount of the premium received.