The skew part II

My point is that this works, and works pretty good.

If market droops your positive vega-gamma will obtein money for you. If market rise your vega become negative, IV droops and you win too.

Your risk here is the volatility evolution when market goes back, you have not close your position and volatility don't regain its original value.

Then you'll lose money, but this is the game here, isn't it?

Regards

 

One more risk sugar - your thetas on your long puts are greater than the thetas on your short calls, since you paid a higher IV for the puts than you got for the calls.

 

Think about it like a vega-scalping strategy.

Remember that skew only affect your position if your put/call volatility spread changes. It really happens but is less important that volatility evolution. You bet.

Regards

 

Just out of curiosity, is there a term to describe the other side of the "scalping gamma" trade?

 

The other side? You mean if you start out delta neutral and short gammas?

I would just call that being short premium. In that case you'd want to lose the scalping bit, because negative gammas means every time the underlying moves your deltas move against you and you lose money. So every time you even up your gammas you're locking in a loss.

 

dmo,

Let me try to understand and conceptualize where you are coming from. By deduction, the reverse of your example should also hold true:

Assuming flat volatility curve (say 20% as per your example) for both calls and puts then - I could short puts, buy calls and short the underlying to remain delta neutral.

Could you provide a simple numerical example of how the above would also produce consistent profits? (given the hypothetical situation where the volatility curve remained flat)

Best,
Chirag

 

You're forgetting the most important element of the whole play Chirag - the relationship between the underlying and IV. This would work in the S&P options ONLY because every time the S&P goes up, IV goes down, and vice versa.

So yes, if you found a contract with the opposite relationship (when underlying goes up IV goes up and vice versa) and you could buy OTM calls and sell OTM puts at the same volatility, this play would work.

 

both spx and vix are up now as we speak. spx up 0.4% and vix up 3.7%. i've seen this happen many times. their relationship isn't as consistent as you claim.

 

I'm attaching a one-minute chart of the SPX vs the VIX from today's open until this minute. Ignore the opening VIX bar, which is a data glitch.

If this is the best example anyone can come up with to disprove the tight inverse relationship between the SPX and the VIX, then I rest my case.

 

I apologize for being so late to thank you for the example Dmo, since I was one who asked for. It wouldn't be polite, so thank you for your work and for your time.

BTW, you wrote "you sell futures to get delta neutral..." with which delta from which volatility, how long you do it (since futures have low transaction costs)? It could be interesting to see how you do it with skew. Some modifications, variations.