IVolatility Egar Service

Gentlemen, please !

Once again you seem to have taken offence when someone (this time Mysticman) points out what he thinks is an error in your thinking. The “saved a bit on commissions” appears to be more than swallowed up on the extra wide spread, not to mention the risks associated with trading an illiquid market. Your original question “Why this product is so illiquid ?” has been well and truly answered. If you are too proud to learn / contribute / debate constructively then why post ?

I don’t know what you’d call your trade but I do know this – it’s nothing like a reverse dispersion, not even close. But I’m genuinely pleased it’s working for you, well done.

Riskarb

Whats “abs-vols” and “buy the box” mean ? Thanks

 

Reverse dispersion trade, partial index replication;

Which stocks to include / exclude in the basket and why ?

Where the index is replicated by (say) 25% of weighted stocks, how then would you hedge that position using index options ? In what quantities ? How would correlation be brought into this equation ?

 

"Buying the box" refers to running the dispersion with at +vol edge -- long index vol at x, short component vol at x+n, long corr. It doesn't assume position-edge as this is a corr & variance play. Shorting the box refers to being long components/short index, short corr.

 

I had suspected as much, but wanted to check.

ABS Vols = absolute ?

Would a low vol environment necessarily favour a long correlation trade ? Likewise, would a high vol environment necessarily favour a short correlation trade ? Wouldn't you need to run the numbers to determine the implied correlation before deciding which way to go (long or short correlation) ?

Struggling with partial replication, hence the questions in my previous post. Any help appreciated, as always.

 

Absolute, correct.

Yes, long the box/long corr has performed better in a low-vol environment; at least in the dispersion/replications I've done; in the sense that low vols tend to mimic forward vol and lack of component outliers.

 

Edit: in the sense that forward stat vols tend to correlate to low-implied vols and lack of component outliers.

 

not trying to start a fight...
this file is clearly shows that components weight is way more important that delta imbalance (for initial position).
Notice that under this particular end of the month scenario actual profit (H39) is equal expected (F39) while delta diff=323k(L38)

 

Not trying to start a fight either but.....

Have a look at MSFT, AA, PG which all expired OTM yet show a bigger profit than the short premium received.

Have a look at MO, which is trading (74.84) ITM against the 75 strike Put, yet is showing a delta of 48.45.

How have you adjusted for component weight ? As far as I can see you've sold every stock Put in the same quantity (30) ? The DOW is a price-weighted index, what divisor are you using ? The portfolio is not correctly weighted for a reverse dispersion.

To calculate $Delta (what you call total delta) multiply stock price x option delta x option quantity. Not strike price.

I'm not quite sure what you're trying to illustrate with the spreadsheet ? In a reverse dispersion / long correlation spread where everything expires having correlated +1, you keep the initial premium, of that we already know.

To suggest that all stocks going down 3% will cause the DOW to fall by 3%, implies that all stocks are equally weighted in the index, which I know not to be the case.

PLEASE don't take offence, we need constructive discussion here...

 

I am also not sure what the spreadsheet is intended to prove. I think the weights of the Dow stocks are an issue, since the heaviest 8 or so stocks have twice the weight of the lightest 8 or so. Another problem is the lack of delta weights with the options. By selling 30 options for each stock, some ITM and some OTM, neither the weights of the stocks nor the deltas of the options are balanced. Most of this will not show up in this example given the perfect correlation.

I have recalculated the end of month P&L to account for those options that expired worthless, as Profitaker has pointed out. This results in a minor adjustment. Instead of a profit of $45,724 upon expiration, the profit is only $39,213 -- still good.
If the Dow index expired right where it is today, you would get to keep most of the net premium sold, or $37,810.
Of course if the market rallies from here, you get to keep all the sold net premium.
It looks like the market would have to drop substantially for this strategy to lose. Perhaps my calculations are in error.
Because there is much more premium sold than bought, this position seems to be a pseudo-replication (close aproximation) of an ATM 2x1 index put ratio write.
Still, there may be some problems with the assumptions here but it is late so let's see if someone else can find the fly in the ointment.

 

Correction: rather than a ratio write, the position simply replicates to net short slightly OTM index puts.
It would be interesting to see a P&L graph of the position at different strikes.