QQQQ/SPY Imp Volatility considerations with a mean reversion swing system

Discussion in 'Options' started by J-Law, Jul 5, 2010.

  1. J-Law


    If one were to trade a mean reversion swing trading system
    with a length of holding time of 7-10 days using OTM/ATM/ITM options, how would Imp vol impact the long side of this trade?

    For starters & comparison...If I sell the rally, getting long puts
    I would have both price & an increase in IV in my favor on the trade as the mkt sold off, thus increasing put premiums.

    But what about on the long side?

    Getting long calls on a dip? Price movement would still be in my favor. However, wouldn't one be entering the trade after
    a sell off, which would pump up the IV, leading one to pay up for call premium & only have IV deflate as the mkt rallies. Thus, leading to less profit appreciation in the trade regardless of price movement?

    Any ideas to remedy while still being long call premium to advantage the upside rally?

    Yes, this is what one thinks about laying in
    bed on a Sunday morning on a beautiful Forth of July weekend.
    The game is always in play. I'm sure you agree.

  2. J-Law


    Thoughts ???? Anyone??? Anyone ????

    .......Beuller.......Beuller ????
  3. Arjun1


    If you are trading mean reversion in options with a long bias then its you're probably better off selling puts in order to take advantage of IV deflation.
    Of course the mere mention of selling naked puts outrages many traders with many horror stories to tell about that strategy but as long as you don't go crazy as far as leverage and you have a real edge then selling an option is no more riskier than buying one.
    The more OTM your option is the more impact a change in IV will have so buying OTM calls on sell-offs makes no sense as the subsequent IV deflation on the rally will greatly limit your profits.
  4. J-Law


    Yes, after doing some Googling I have come to that conclusion as well. I am not adverse to selling put premium, as that makes a great deal of sense. SHort gamma in a falling IV situation. However, the acct I set to trade in has a short option limitation/resriction as it's an IRA acct.

    I have been reading that deep ITM calls on a dip might be an alternative as they have less sensitivity to IV changes.

    What do you think?
  5. spindr0


    Yup, with an IV deflation you might even lose on your calls despite a nice bounce. Here's a cherry picked May example for the SPX. Looking at an IVolatility chart, IV peaked about 5/20 with SPX closing at 1071+. Over the next week, SPX bounced 30+ pts but IV contracted about 10 BPs. I doubt that an ATM call would have made much, if anything. ATM would have fared much better but then your exposure is significantly more if your reversion fails to materialize.

    Selling some premium in a wide vertical would reduce your long call vega exposure but it's a guessing game as to how much benefit that adds because there are so many moving parts (subsequent UL price & IV change, time decay) as well as the limiting nature of the short calls to the upside. With ATM, you'd most likely do better with the vertical unless IV reflated again.

    It's a bit of work but looking at some historical data might get you closer to an answer.
  6. charts


    ... :)