Well when I had my ass handed to me last thursday, I started flat vol, long gamma, long theta... a dream right?!! - It was a position that I had got myself into in a quiet market trying to eek out some stress free cash. Unfortunately this had been done at the expense of being short skew (long skew calendars)... So when markets tanked and skew went BID and sellers literally disappeared... it was very difficult to get out of. The problem with many option strategies is that when markets are behaving themselves, you can see your "out" should it be required. However things like offers can literally vanish from the screen and broker market. With regard to the in depth discussions here about gaussian distributions, geometric brownian motion, (and sharpe ratios in options?? really???)... modelling methods are all methods to fit the vol curve / surface to the market prices, often post ante, and do not tend to make a HUGE difference when to the supply and demand forces in the market as it reacts to new news / greed / and panic. The model I trade with models the IV using vol, put and call skew, put and call height, put and call rolling AND super rolling height. And I hedge all delta exposure, interest rate exposure through a strip of interest rate futures real time, sometimes div's out the back (or indirectly through synthetics) and I trade out to Dec14. And with BSM business day count. But I think that it is more important to have a simple model which one can understand, know the little nuiances and fudge factors etc, than to get too lost in the mathmatical detail in which the bigger picture may get lost. Ie. We are trading vol - or markets attitude to risk, certainty and panic. Get this right and it will make you more money than by fiddling with the models.
Don't know why I attached that quote Martinghoul... I agree with everything that you have said. It was in reference to your anti short gamma line. Which I agree with generally.
Wow, Veyron is back. So you model your super rolling height? Wow, impressive. You hedge rho but you got spanked last week on long gamma? Even more impressive. I'd like to hear more about your dividend hedge, "indirectly through synthetics"
?? i wasn't trying to be smart, just home after a couple of beers and rambled. sorry if it came across that way. I wasn't claiming to have written the model, I just move the inputs to try to fit the curve to the market across all strikes. I just try to reduce my back end exposure to things like riskys by trading the roll to reduce my chance of getting screwed when dividends move. Which has a big effect that far out. Is that so impressive???
I would have that beer tested for PCP. No big deal, but little of what you wrote made sense to me. Don't you find that dividends are inherently unpredictable? I've never known anyone to take a dividend hedge inside a year, and the ones that do hedge long-duration generally assume that it's parallel to rho and a macro-bet on a strong/weak global economy. What does "indirectly through synthetics" mean, and how did you lose last week on long gamma? Modality? Just curious, not being antagonistic.
Oh. got it. Firstly I am a market maker. Hence try to hedge out as much exposure as I can to leave me with vol. exposure only. If I sell say a Dec12 risky for the put, 60D, then sell my 60 deltas. (June expiry futures) Then hedge a rate strip. I look to just have a vol exposure. However. if divs move, then suddenly the Dec12 risky which I sold over sheets (mid point of bid-ask at the time) can suddenly be an off side trade. So if it was a large trade I might also but 60 Dec12 synthetics and buy 60 June futures (the roll) to reduce the exposure to the sum of the dividends which go out to Dec12. Alternatively one could go into the div swap market, however this is very illiquid. Your second question, if I sell a front month put and buy a front month call, due to the vol skew on an index, I can get long gamma and long theta. Eg put is 1:-1.8 and call is 1.2:-1.6. This leaves me 0.2:0.2. As the market falls, the puts become more ITM, and you get shorter gamma. Also puts go bid... making it worse. And also you become short vol. Even worse. So it is great when markets sit still, but not during last week.
OK, so long gamma via symmetry, so I assume you're short spot into the long risk-reversal? Understand the context as a MMer, but I've never heard of "super rolling height" Thanks. Have a nice weekend (started early).