Watch HowardCohodas Trade Index Options Credit Spreads

[HowardCohodas]

I can point you to a book... Will that help?

It's section 2.8.6 of the 2006 edition of Collector's (aka Espen Haug) excellent reference text "Complete Guide to Option Pricing Formulas".

Our posts crossed in the ether.

 

[Martinghoul]

Our posts crossed in the ether.

Indeed... Generally, I can't recommend this book highly enough (as reference material, rather than for educational purposes). It's everything your heart could desire in one place.

 

[meanreversion]

Just eyeballing those forumlae, do they add up to 1, i.e. this is slightly different from the premium of a one touch, which will always be discounted.

Secondly, I assume the vol being used is the vanilla adjusted vol, allowing for r/r and fly?

 

[Martinghoul]

I shouldn't have forgotten to mention that these are risk-neutral probabilities, to be sure.

meanie, I haven't actually gone through the motions and checked whether they add up to 1. Lemme do it, 'cause it's worthwhile exercise and it shouldn't be rocket engineering exactly.

As to the vol, this is the good ol' world of BSM, so there can be only one vol. You can't compute this in the presence of skew, unless you parameterize it (i.e. use some sort of a stoch vol model).

 

[meanreversion]

I shouldn't have forgotten to mention that these are risk-neutral probabilities, to be sure.

meanie, I haven't actually gone through the motions and checked whether they add up to 1. Lemme do it, 'cause it's worthwhile exercise and it shouldn't be rocket engineering exactly.

As to the vol, this is the good ol' world of BSM, so there can be only one vol. You can't compute this in the presence of skew, unless you parameterize it (i.e. use some sort of a stoch vol model).

BSM is fairly archaic and known for underpricing low deltas, no? Are you saying that it can only accept the ATM vol for each period?

(Nice touch about rocketry.. should be in pedants corner in Private Eye with that)

 

[Martinghoul]

BSM is fairly archaic and known for underpricing low deltas, no? Are you saying that it can only accept the ATM vol for each period?

(Nice touch about rocketry.. should be in pedants corner in Private Eye with that)

Hehehe, I knew, Pedant's me middle name...

As to the vols, the whole point (which was among the things I mentioned to HC in an earlier post) is that the beauty of BSM is that it's simple, tractable and offers all these nifty closed-form solutions. The price of this simplicity is that the assumptions are not entirely realistic. As far as I know, in a world where volatility is not constant computing this "probability of touching" is a much much trickier proposition and requires quite a bit more than high-school calculus. Probability of being ITM at expiry (which is the other number in TOS that HC may have mentioned) is another matter, as this can be obtained numerically by differentiating the smoothed price(strike) function twice. But that's a different kettle of fish entirely.

 

[meanreversion]

I recall when they started that section, it was called "Pedants' Corner". Then some pedants claimed it should be pedant's, some said just pedants. Then it was changed to pedantry corner.. it was amusing for a while but then it became a little painful.

Anyway, I digress, back to chinstrokers' corner. I feel after 70 pages we haven't really come very far.

1. There is no discernible edge
2. The strategy assumes implied vols are systematically too high, or to put it another way, the position will be short gamma/vega 95% of the time
3. The management of the position when things turn sour is key; in fact it is probably far too important, there's too much scope for it to go wrong (but obviously this is not something that can be proved at this stage)

 

[HowardCohodas]

1. There is no discernible edge
2. The strategy assumes implied vols are systematically too high, or to put it another way, the position will be short gamma/vega 95% of the time
3. The management of the position when things turn sour is key; in fact it is probably far too important, there's too much scope for it to go wrong (but obviously this is not something that can be proved at this stage)

Now attached to my monitor stand to remind me of areas that need my attention. Thanks.

 

[Martinghoul]

Anyway, I digress, back to chinstrokers' corner. I feel after 70 pages we haven't really come very far.

1. There is no discernible edge
2. The strategy assumes implied vols are systematically too high, or to put it another way, the position will be short gamma/vega 95% of the time
3. The management of the position when things turn sour is key; in fact it is probably far too important, there's too much scope for it to go wrong (but obviously this is not something that can be proved at this stage)

Well, I am not sure I agree 100% with this assessment, so let me tweak it a bit to match my current understanding (apres 70 pages).

1. There may or may not be some edge in what HC is doing, but it's difficult to ascertain without very explicit cooperation from HC himself.
2. To echo point 1, the strategy assumes that vols are too high for specific configurations that HC chooses to trade, rather than systematically. So it's entirely possible that his edge is precisely locating these configurations.
3. Indeed, there are some strange and not very understandable elements of the method that HC uses to manage the position, such as the "legging" of his ICs. Moreover, it's hard to imagine that any of his edge resides in the risk management area, so the money mgmt discussion is a bit moot.

So, HC, we're back to the original question. Do you want to delve into this further or you wanna keep flying solo?

 

[HowardCohodas]

So, HC, we're back to the original question. Do you want to delve into this further or you wanna keep flying solo?

I'm committed to discovering all I can about what I'm doing. Any perceived lack of cooperation should be put down to my inability to understand the language or importance of some of the questions. You guys have caused me a lot of sleepless hours trying to learn enough to have some semblance of coherence. Apparently no not much avail.

 

[meanreversion]

If I look at the successful traders I've met, that there is existence of an "edge" is not in doubt (although this is probably stating the obvious).

How then, is an "edge" derived? Either the person does intense amounts of research and/or studies the market(s) for several years, or they are particularly well connected/informed (or indeed all of these). In addition, the successful traders are necessarily intelligent, but also possess the ability to look at the larger picture and to occasionally see what others are missing.

What worries me with your approach, Howard, is that you seem blithely unaware of why you think you should be making money, other than miraculously dodging bullets when things go wrong. Martinghoul is giving you the benefit of the doubt in suggesting that your edge is in picking overvalued spreads, but I just don't see it. Your position is more of an options book given all the different strikes, so at the very least you should be aware how your delta, gamma and vega change when spot moves 1, 2, 5 and 10 pct (and monitor this daily - and realise what it all means!).

However, your risk management (and indeed your understanding of options) is stuck at a fairly basic level. I know you've built a pretty looking "dashboard" but this isn't enough, in my opinion.

There's not a lot left to say. I hope you don't get burnt, and maybe you'll work these things out in time. That's all.

 

[Martinghoul]

I'm committed to discovering all I can about what I'm doing. Any perceived lack of cooperation should be put down to my inability to understand the language or importance of some of the questions. You guys have caused me a lot of sleepless hours trying to learn enough to have some semblance of coherence. Apparently no not much avail.

It wasn't so much intentional lack of cooperation per se. More just our inability to use a common language.

So would you be willing to subject just one of your trades to some scrutiny? Specifically, would you be able to describe why you sold a particular spread at a particular time and a particular price?

 

[HowardCohodas]

So would you be willing to subject just one of your trades to some scrutiny? Specifically, would you be able to describe why you sold a particular spread at a particular time and a particular price?

You bet. Let's start with today's trades. I would suggest that I also tell you about the trades I passed on and why. I believe looking at both sides of the decision will illuminate what is going on in more detail. What do you think?

 

[HowardCohodas]

If I look at the successful traders I've met, that there is existence of an "edge" is not in doubt (although this is probably stating the obvious).

It should be obvious by now that I don't have a clear idea of what you mean by an "edge." Surprisingly, my search among many trading boards does not clearly indicate that I'm in the minority.

So, for purposes or our discussions, can you illustrate it by example? Tell us about a trading strategy, show us what you mean by an "edge," and how it works. Perhaps even yours would make a good illustration.

 

[Martinghoul]

You bet. Let's start with today's trades. I would suggest that I also tell you about the trades I passed on and why. I believe looking at both sides of the decision will illuminate what is going on in more detail. What do you think?

Agreed... But can we pls just use two examples, a trade that was eligible and one that wasn't?

 

[HowardCohodas]

Agreed... But can we pls just use two examples, a trade that was eligible and one that wasn't?

That's my plan. This will be a separate post from my daily summary to minimize confusion. Or I could start a new thread specifically for this purpose. I'm leaning in that direction.

 

[robster970]

Put it in here - the deconstruction by MartinGhoul will be invaluable and in the context of your thread IMO.

 

[scose-no-doubt]

You guys have caused me a lot of sleepless hours trying to learn enough to have some semblance of coherence.

Now you're a member of t2w.

 

[Martinghoul]

Put it in here - the deconstruction by MartinGhoul will be invaluable and in the context of your thread IMO.

I agree with robster... I think it would be useful for us all and I hope to learn things in the process.

 

[HowardCohodas]

On the PUT side.

1. I plan the areas where I will look for trades in the previous evening or the morning of the current trading day.
2. I wait for 30 - 60 minutes and check the volume, especially when the overnight futures indicate a significant opening move.
3. I'm looking for the strike I will short. For weeklies, I'm generally looking for around 15% PoT (Probability of Touching)
4. At the close, POT was 14% on the 2200 shorted PUT
5. Next, I want to see adequate open interest. and some volume given we are 30 - 60 minutes into the trading day.
6. If there is a strike to short I then check the credit I will receive if I create a spread with the long being one strike away.
7. The credit amounts were not generous. I look for 5%. I'll go no lower than 3%.
8. The nearest strike to go long is $25 away. 3% of $25 is $.75. I received $.80 when I put on the spread.
9. At the end of trading the Mark price was $.875
10. Should I have to bail at this time, I will pay $1.75 ($2.00 - .25) and suffer a 6.4% loss on capital at risk.

On the CALL side.

1. Open interest adequate
2. Volume adequate
3. The 2300 CALL was close to 15% PoT.
4. The credit offered was low.
5. I put in a LIMIT DAY order for $.80 credit and it expired.

That should give you guys a good start.