So I remembering reading quite some time ago that some floor traders use to have a setup that made good money and was quite safe. They would buy a straddle say 9 months out then sell front month strangles against it. If stock broke up/down you would just buy/sell some stock/futures against it and if it made a big run you would just let the straddle run. Do you think that this still applies today now that everything is electronic?
Long a straddle + short a strangle = isn't a flat line for a payoff? How do you make money from that?
They were market making and skewing their books. It's very different from electronic. You are filled last and only when market maker deem the fill to be in their favor.
Different expires long straddle is far month short strangles are front month. So you sell 9 strangles worth of premium and covers +/- the cost of the straddle then whatever movement you have from the strike of the straddle at expiration is profit as well.
They weren't MM just pure traders. Sure they probs got some edge on the fills but that was only a small portion of their profit.
First of all what you are describing is a position, not a strategy. Second, it depends on skew and term structure. If 9m vol is cheap and 3m are expensive, you buy 9m straddles and sell fewer expensive 3m against it to have a flat gamma profile. Tgis way you are long vol and long wings. If term structure is in contango, you can sell 9m flys and buy cheap gamma in the front months to be long wings again. Ideally you want to have a flat skew in the back months to get your wings for low vols. Don't thing prem, think greeks. High vol-> low gamma, high theta, which is a good sale against low vol - > high gamma, low theta
Thanks for the reply but you have over complicated the premise of what they were doing. The short strangles and long straddles netted out in number of contracts held. While higher action/volatility in the front month is a plus it wasn't a prerequisite. They only adjusted by buying/selling stock/futures when the price made a larger mover outside of the strangle.
Nah, not over complicated. As a MM they always wanted to be neutral, also to vega. Flat skew - > Butterflies (that is short vega with stock at the body) -> buy high vomma wings so that you are vega neutral but long vega convexity. When vol goes down and stock trades at body, you win. When market explodes, you win Backwarded term structure -> Ratioed calendars (long more long term than short term options). When front vol goes down or time passes, you win. When market explodes and vol goes up, you win. The goal, however, is to build a position that is stable over a variety of scenarios and covers your ass once the shit hits the fan. Spreads where huge back then and you always wanted to be able to make markets. More often than not, they ended up with a wonky ass portfolio that had a ton of strikes and terms, but above mentioned positions where the best case It more or less comes down what Toni Saliba called an explosion position. And yes, you need favourable term structure and/or skew to make these work. If you...like a tasty trade retailer...buy calendars with the short term vols trading lower than long term vols, you end up with a position that has huge vega and very low theta to balance that. Vols are mean reverting, so you wanna buy low and sell high...not buy high and sell higher
Yea I understand the MM's wanted to try and convert all the shit they had to flys. So what you are saying is no one did what I said or you just didn't know of anyone doing it? Thx
They did what you said but there was more behind it. The reason why professional traders and market makers are so keen on neutral options trading is because volatility is mean reverting AND vega is linear ATM and has convexity OTM. Meaning if you structure your inventory correctly, it's almost free money. They also knew this back then so they always tried to be long convexity. This is also the reasons why MMs are looking at butterflies with 25 delta wings and 25 delta risk reversals as these are the prices for convexity and skew. An individual option is very illiquid but the market for greeks is incredibly liquid, because you can substitute one options greeks with another option. I'm not sure which interview it was but some guy stated that MMs hoard wings. If you think about it and factor in what I said above, you realize why that is the case. Edge per delta is the biggest in wings. Meaning a one cent spread in an OTM option is much more in vega terms than ATM plus you have convexity at the wings. Joe public trades mostly ATM so this is where you have the most 2 sided flow. When you have a bunch of cheap wings, you can buy and sell ATMs all day without the need for constant readjustment of your hedge. Vol down -> ATM trades lower while OTM doesn't move (you don't lose) -> you can sit on the ATM bid. Vol up -> ATM trades higher while OTM also trades higher (you win more OTM than you lose by being short ATM) -> you can sit on the ATM offer. A MMs nightmare is long ATMs and short wings.