I don't really trade equity options. But I was considering getting some as a hedge last week. If you had sold May 21st ES 1180 calls last Thursday, after that collapse and the underlying was trading at $1120, you could've gotten ~$7.50 for your trouble. Obviously, if the underlying had collapsed further... you would've booked all of that. But today, even after a huge 4% run-up in the underlying, you could still buy back the option at ~$8-9. (On a related note: don't *buy* deep OTM calls... see above.) Just goes to show, you really gotta have awareness of how vega is likely to move with underlying.
Different instruments have different behavior, in terms of how implied volatility moves with price. With stock indexes, implied volatility moves up when prices drop, and drops when price goes up. This is because a large flood of option-buyers come into the market when prices drop. (With other instruments, the relationship isn't the same... coffee, for example, you'll often see implied volatility *increase* with higher prices.) When prices dropped so quickly last Thursday, implied volatility went through the roof. You could've sold calls (expiring in 2 weeks) that were very far OTM, for a decent amount of money, precisely because of that higher volatility. Now, selling calls is usually "bearish"... because you want prices to drop, and because you lose money if price climbs and your call becomes ITM. In this case though, because implied volatility dropped quickly along with an increase in price... the call didn't increase in price (much) even after a 4% jump up in underlying.
Ok I get what you're saying now... but I would have thought you would have been hurt from the huge spot increase. Why don't you just sell vol as opposed to selling calls... thats what I don't get. Wouldn't you prefer to sell puts? That way you benefit from drop in vol and increase in index.
Yeah, that's because the VIX fell from 41 to 28 in one day. However you still got decent gains on the options, the 1150 calls were up almost 150% for example. What you don't want is to be long something like the 1200s which are still fairly OTM even after a big rally. It all depends on the IV relative to the size of the move. Back in November 2008 I bought some deep OTM Nikkei calls when the index was at 7000. I made about 7 times my money in 4 days despite the VIX collapsing. The index move was so big (7000 to around 9200 IIRC) that it overcame the fall in implied vol. 7:1 was a much better risk/reward than going long the underlying. Basically if the move will be large enough, you can almost forget IV. But for more "normal" moves, if IV is really big then it will handicap your returns, and long the underlying is probably better.
Well yeah the holy grail is always be able to isolate vega/iv completely with net 0 gamma/theta, but that will never happen. If your numbers are right, you made a play on high iv betting if the spot goes against you and gaps up iv will drop and offset most of the naked call losses that was written while still remain otm. A vertical spread or diagonal would probably be less risky though
The point is, this would've been a heads I win, tails you lose trade. If you sold puts, and the EU meeting over the weekend failed.. then you would've been on the hook for huge losses. My point is that by selling calls Thursday or Friday, it was a one-sided traded heavily in your favor. If the EU meeting failed, you would've (obviously) kept everything. And even though it succeeded, you basically came out even.
So the trade is based on the correlation between vol and direction, right? Specifically, you're assuming that vol, in the current regime, is likely to come off on a rally and rise on a selloff. Or am I understanding this correctly?