What's the best strategy for being bearish on volatility without gamma hedging

Discussion in 'Options' started by Ghost of Cutten, May 11, 2011.

  1. Let's say you can correctly forecast declining volatility. Is there any way to profit from this reliably and with good reward to risk ratio, without gamma hedging?

    Second question - if you can predict a trading range (it's size and duration), what is the most profitable options approach? Would using any options strategy provide superior R/R to just buying near the lows and reversing near the highs in the underlying?
  2. sle


    Anything aside from variance swaps (or other vol-specific structures) will sooner or later have a directional component. E.g. if you trade an iron condor and market grinds up, you will find yourself short and losing money rather quickly, even if your volatility forecast was correct.
  3. sle


    I am a bit rusty on the whole terminology, but I think selling ATM straddle and buying OTM strangle is an iron fly, while selling a strangle and buying a wider strangle is a condor. And no, if you are not delta hedging, it's more a distributional then volatility statement.
  4. Iron Condors have a shitty risk/reward ratio though. Also, you can be right and still lose money or not make anything, if the market is at the high or low of the range at expiry.

    I highly doubt that iron condors are the most profitable way to play a precisely predicted trading range. How about buy put spreads at the top and buy call spreads at the bottom?
  5. Directional components are great though, because (hypothetically) you know the direction.

    What I mean is, let's say you accurately forecast the S&P will range from 1250 to 1350, with rising volatility, over the next 3 months. What would be the most profitable way to play this? In outrights it's obvious - short at 1330-1350, cover at 1270-1300, go long at 1250-70, exit scaling out from 1300-1330, repeat until the range is over.

    What about with options?
  6. Erm, this is a rather funny statement, methinks... Unless I am getting all dazed (it's late) and confused, isn't what you describe precisely an iron condor?

    In general, the simplest fire-'n-forget structure would be a fly where you try to pin the strike. Iron condors and other variations on this theme are all the based on a similar idea, where you'd do the trade if your view is that the distribution implied by the mkt price of the structure doesn't have enough mass in a particular area in the middle (and too much mass in the wings). These are all variations of a short vol trades. Problem is twofold: a) there's a directional component, as sle says; b) viability of these trades depends on how the mkt prices various strikes.

    My Z$2c. I'm sure the experts' insight is far superior to mine in this.
  7. sle


    If you know the range, you best bet is to sell puts at the bottom end of the range and sell calls at the top.
  8. Didn't you want declining vol (-vega) in your OP? Now you want +vega? Which is it?
  9. lol, his outlook has changed.
  10. Ah, maybe I forgot to explain properly - I mean you would exit the put spread near the bottom of the range, before you put on your bull call spread. Essentially you'd be making bets on moderate falls when the range is at its highs, and vice versa when at its lows. The spread would be used to keep the vol exposure moderate, since you expect it to decline.

    I have tried with butterflies, but the problem is that your results at expiry depend so much on luck, what if its at the bottom of the range at expiry? You would be right on the range, right on falling vol, and still have a bad result. If you use iron condors wide enough to avoid this risk, your return kinda sucks. Plus you have those wonderful 4 commissions and bid-offer spreads to pay :)

    At least with the vertical spreads, it is fairly obvious what to do. I'm fine with taking a directional view, since I would only put these on when I think I can anticipate it to some extent.

    Reason I don't want to gamma hedge is I would only put on short vol positions when I'm pretty confident about a range - if I'm wrong then the other spread leg will cap the loss.

    Someone might suggest just using outrights. The problem here is your outlier risk in case of some news event; and the risk of being faked out if there is a false breakout for a day or two. Trading ranges are notorious for triggering stops at either end, then reversing a few days later to re-enter the range. Having on a limited-risk options position lets you sit through such noise with impunity.

    Disclaimer, I am a total noob at trading volatility, so I am probably missing some fairly obvious stuff here.
    #10     May 11, 2011