ok..since we are on the topic of volatility..the above was from OCT 21 last year. Interestingly IV was around 16 which a year later looks pretty high. This begs the question when looking at current vol's vs historic vols, how far back in history would you go? If we are doing month to month credit spreads wouldn't most recent history,say the past three months, or six months be more pertinent. To me current vol's are pretty low compared to the average IV so far this year. In 06 we have only had a brief period of high volatility...May/June. So IV under 12 seems to be not very favorable toward opening credit spreads (except perhaps for the call CS) OTOH when IV is high... doesn't the volatility indicate large future movement in the delta's giving you a bit of heartburn? Up 15, down 20, up 10 and so forth. The reason I ran across this post is that I am compiling a "Best of MO"...edited, organized and presented in book form. Available Jan 07 for the low low price of $1000 a copy!!! edit...J/K :eek:
I've read very little on the subject. I started solving for partials via BSM, Whaley, CRR, Tri, etc... through Hull's first edition and various white papers. Good, recent editions: http://www.amazon.com/Arbitrage-The...ef=sr_1_1/102-1648603-7138555?ie=UTF8&s=books http://www.amazon.com/Martingale-Fi...62/ref=pd_sim_b_3/102-1648603-7138555?ie=UTF8
The best? So, about 2 pages long then LOL. I obviously meant reversion rather than regression. WTF? Front month credit spreads do not have a lot of VEGA and the main risk is obviously GAMMA but the point I was trying to make is still valid I believe. That's a good question with respect to how far back one goes and whether one needs to consider if perhaps a fundamental shift has occured or not from days gone by. I don't have an answer. Even at VIX 16 some people would still shy away from being short index gamma. We'll see what level VIX reaches post-election etc. I understand what you are saying about higher implied volatility leading to possibly greater heartburn but consider this: If IV was at 20% and you opened a 90% probability credit spread (which would be WTFFOTM compared to today's levels). If IV then suddenly dropped to 15%, your 90% probability credit spread would become a 95% probability spread (I'm making the numbers up). You still have a chance of losing on the spread but if you can weather the storm whilst IV reverts to a certain level then you end up in a statistically advantageous position. It's like you were able to go back two weeks in time and open up the spread for a larger credit than the one you would get if you opened it up today (after the reversion). After all, implied volatility is synthetic time. It's probably better understood when looking at buying or selling straddles and the effect of IV vs. realized volatility. IMO, the heartburn comes about when a spread is opened on low IV and then suddenly there is an explosion in IV which translates to large movement or vice versa thus possibly threatening your spread. Erm... MoMoney.
With your big brain, can't you invent a Matrix style knowledge transfer mechanism thingy? NEO: Can you fly that thing? TRINITY: Not yet.
I understand the whole concept so much better this year as compared to last year. I see what you mean with the reduction in vols creating a higher probability spread. I guess thats why on my Nov spread and the rest of the Oct spread I'm putting on some debit spreads for "convergence" gains aka Riskarb. I'm amazed at how much I have learned from you guys this past year!
Guys, I have been testing the cross month same strike short Butterfly (i.e. short OCT/long NOV/Short DEC). with OTM strikes. I got option Greeks for the ES and EW options and I have been pricing and doing different scenarios. If I open a call FLY, for example, using OCTEW/NOVES/DECES and choose a 1390 strike (ES at 1358) I could do so for a net credit of about 2.30. T The goal would be to close out the entire position at the expiration of the first month which hopefully will expire worthless. If the market drops sharply by expiration, I can still close out the spread for a small net credit. If the market surges, the cost to close could widen a bit but it would not be a large loss. If the market stays flat then when the short expires the other remaining positions (a calendar backspread) can be closed for a nice profit. I have not finished all my research but the profit potential seems pretty good while the scenerios for loss seem limited and controllable. deltas do not really go too positive at the first wing expiration. Also if the short expires you can adjust the other two positions if you want ( more to come on that). It is hard to test on a graph like in TOS due to different time elements but looking at current ATM, ITM and OTM positions and their greeks I am getting a sense what changes occur in the position although theoretically. I will do more research and open a small position to really test... First potential position: - OCTEW1395 Call +2 NOVES 1395 Call - DECES 1395 Call Possible net credit = 2.45 per FLY. I will let you know. Remember goal is to close out on expiration of first short wing. EDIT: I could model the two separate calendars but ToS does not allow for modeling of ES/EW futures. I will see if I can do it for SPX equivalents.
OC , lol , your trade is exactly the opposite of what I'm testing now. What are the margins req for your trade ? (we both have one naked ATM call , so retail margins should be the same/close)
So now you are trying to finance the nov/dec long calendar with an oct/nov short one? What happened with the long cross month fly?
In the prop account the haircut should keep the margins practically close to zero given the deltas of the entire position. If I look at deep ITM and or deep OTM spreads as of today, the total net position deltas is still near flat. Retail will count, in my hypo, the DEC as a naked call, but not in haircut. I may ask MAV to compute it for me to see but I cannot see how it should have much of a haircut given the delta calculations. P.S. I am only looking at call right now to take out IV affects since IV does not spike on a move higher. It does spike on a move lower but since it will move further OTM the deltas take care of that mostly (i.e., all calls drop in value combined).