I agree with what you are saying here, Vol has no upper bound. It would be interesting to see a study of Vol expansion on a daily basis, say during the financial crisis. What I would want to know is if it expanded faster on a per day basis quicker than time left in an option trade. Now I'm guessing here but I would think even during that period of time, there was no expansion (VIX) or maybe small contraction. Overall though, it was up. Now, as far as going too far OTM. So far, I only have considered this type of trade when IVP (Implied Vol %) was 100%. Even though it can continue to stay at 100% (because the IV continues to expand past its 52wk high), I personally think it would be better to do it then instead of it being lower. I may catch a small contraction prior to option exp. And if I'm a good number of SD out of the money, I'm betting that directional movement will eventually slow even if it is moving towards my strike and then time decay starts to win in my favor. No guarantee that it would work but I think that would be a good trade entry for a 30-60 day strategy. Al the researcher on tastytrade takes a step further and waits for historical Vol to begin contracting on an underlying once the IV has expanded to try to better catch the contraction of IV. Anyway, great discussion, I having a blast (plus the markets are actually down a good amount today!) I have some debit spreads for the month August and I'm short the equity markets. Hopefully tomorrow follows through also.
when implieds go up, everything gets more volatile - including the vol itself. so 100 vol can become 120 or 80 in a blink of an eye. Given the convexity against you, it's often hard to sell that.
your correct, if vol is "realtively" high then going FOTM is "safer" than when vol is low....however if your placing a bet on lower vol then why go really far out? Far more meat near the money. sheesh..I must be channeling other traders the above statement was not me 10 yrs ago I agree with Al..however I have difficulty trying to be that precise in timing either direction or vol.
Duke, the best hedge is probably going to be your position size. Just trade small. Don't hedge with futures. The other thing you can do is trade against it with something else. Say you were short ES calls, buy some AAPL against it. Assuming AAPL or whatever stock is strong.
You are trading one unbounded risk for another. It's like saying you stopped doing heroine for meth. The risk hasn't changed, you just flipped the modality.
Or to put it another way, you have to ask what are you REALLY trading? (another question is are you actually trading the same position with multiple correlated instruments that only seem to be different) "you are more likely then not to not be successful if your strategy seeks out small winners" i.e you must risk a little to make a lot - you are looking for dramatically skewed risk:reward profiles.
Hm, I am a bit confused. Let's say I short 4 ES calls, and then if certain level is broken to upside, I buy 1 future contract. What's wrong with such hedge? Thanks
Because you went from unlimited upside risk to unlimited downside risk. You can call it a hedge all you want, but it's not really a hedge. It gives you the illusion of stability as your p&l over the very near term will be less volatile. But if vol continues to increase, you're going to have a major headache. I'm not sure if you traded this way back in 2008, but I can tell you how bad the whipsaws were. In this case, you would be better off buying ATM calls or slightly in the money calls as a hedge. That way if the market goes limit down you won't get chopped to death by selling the future in the hole 60 handles only to watch the market shoot up 90 handles the next day when Bernanke announces QE 7 and you're naked calls all over again. Rinse and repeat.