I actually always glance at the ATM straddle and try to make sure my strikes are well outside of that range at a minimum. If I can translate riskarb's comment into our English (and risk arb feel free to correct me), is that the ATM straddle is being priced by the market maker on current IV estimates to cover the potential range of index moves from that point to expiration. If the index is at 1260 and the 1260 JAN straddle is at $40.00 then the MM are pricing based on an expected distribution of 1300 and 1220 of the prices to expiration. Since they want to price the straddle so that they are covered on buy or sales, you assume that their straddle pricing is a their good estimate of the market range they see as of that moment over the life of the straddle. This changes daily with volatility and index changes but gives you the range distribution.
Please refer to OC's less nebulous explanation ^^^ as it sums it up well. I don't think the SPX will take out the highs, and went short the Nikkei on yesterday's SPX performance. It's a trade with a 7-day horizon. The SPX closed well below the value-area on Market Profile, and it's been pretty accurate recently with these range-expansion days. My SPX projection was bearish, but I don't think we take out 1236 as was mentioned by piccon. Simply IMO.
Still looking for some mini-bounce in the S&P overnight/pre-market/morning. I am not as bearish as I am neutral, i.e. lot of sideways movement over the next week or so. 1250/1270 with perhaps a dip to that 1245 level.
To be sure, to be sure, there's gold in them thar posts. Distro = distribution. It's generally accepted that IV of ATM options (CALLs and PUTs) are a good predictor of future volatility under the right circumstances. There are numerous papers written on this subject with varying conclusions on best time frames and CALLs vs PUTs etc. so I won't bore you with the details here. Using the IV you can infer an Implied DISTRObution of future prices and therefore make your strike selection based on that if you are executing a FOTM strategy. Not sure that all helps. Momoney.
Thank you riskarb and (coach for explaining). I usually sell > 1 std. deviation away. The ATM straddle cost is a great way of looking at the range of index movement (to expiration) based on current IV. A formula for the estimated move (EM) of a stock or index: EM = Stock price (SP) * Historic Volatility (HV) * Sq. root of days to expiration / Square Root of 252 (Trading days in a year) if stock is at 100 HV = 40% days to expr. = 2.5 . sq. root = 1.58 then, EM = 100 * .40 * 1.58 / 15.875 = 3.98 So, the stock will trade within a range of 4. 68% (1 std. deviation) of the time
Basic approach is try to stay outside of that range and add more strikes if you do this. MM can be wrong and unexpected events can change things so do not try and hover on the fringes of the straddle ranges. For example with index at 1257 the 1260 JAN straddle is price at $39 at the ask with 43 days to expiration. You want a clean cookie cutter approach? Start at 2x the straddle price when looking at strikes. It is always best to study the charts and look for resistance, support, blah blah when selecting strikes, but for quick back of the envelope study you can use this as a guide to find your starting points.
Cool I just got my first Xmas present. I'll always keep that in mind now. Jeez, I guess all you have to do is ask! Thanks all. Now if I can just figure out why were trading on the Nikki.......
14% vol. Japan goes absolutely comatose around the holidays. Looking for a range contraction since I've essentially sold all the available gamma I could get my hands on. Think global index markets will trade a little lower as well. I realize it's OT, but you asked. Anyway, get back to the business at hand, sorry for the interruption.
Since I'm on a roll here, could you explain "sold all the available gamma"? What constitutes selling gamma, shorting? sd
Japan market is usually dead around this time of year, except for that one January where Nick Leeson bankrupted Barings LOL. j/k