Bear Market Strategies Time Spreads And Straddles

Transcription

1 The Option Pit Method Bear Market Strategies Time Spreads And Straddles Option Pit

2 BMS- Time Spreads and Straddles What we will cover: Simple Capital Allocation Stock Replacement Time Frame The Juiced Time Spread Long Gamma, High Volatility trading (Bear Market)

3 Capital Allocation The Biggest Issue in a bear market? Lack of capital and try to catch a falling knife. Stocks are in the can because sellers are raising money. Do you have any? SPX was 1250 in May That is a near 50% return for anyone with a few bucks ready to go.

4 Recent History The biggest defense is to have ready cash all the time no matter what. Think of the greatest investor, Warren Buffett. He sits on a stock pile of cash and uses it when the opportunities present themselves.

5 What were you doing here? Recent History

6 Capital Allocation and Strategy The key is do not rush. While Capital Allocation is not a subject here think about your exposure. You need a strategy prior to the meltdown on target issues. Ultimately, do you have the ability to respond when the market tanks?

7 Setting up strategy and time frame The investment decisions are based on time frame: Longer Term of a 1 year duration: looking at ownership Delta and Vega position- managing the direction by Vega Shorter Term of a month or less: This is a trade looking to unwind Gamma and Vega position- managing the direction by Gamma This is so the average investor can be short term wrong but long term right.

8 Why Buy Options? Fallacy of buying options- you can never make money buying options If the market is moving faster than the implied volatilities are priced, option buying is almost always preferable. Why? The options are pricing a standard deviation move less than the market is actually moving.

9 Pricing Implied Volatility

10 Using Vega The vega and P/L of a position changes when the IV changes The premium sellers forget that IV can go up and that gives a long option position another dimension. For a 1 year time horizon, use Vega to your advantage Using a time spread and long call as stock replacement.

11 The 1 Year duration position EEM is currently in a declining market. 100 shares are around $38.90 or $3890. Think about reallocating and changing the position shape Increase the delta by 50% but cut the cash in half Money is now on the sidelines and part of the position Buying longer term just ATM or OTM calls and a put time spread

12 The 1 year duration position

13 The 1 year duration position

14 The 1 Year Duration Position Managing the position requires just a couple of moves if the underlying moves. Roll the put spread if the IV really jumps to reduce vega Might have to roll the calls down It could be a very small loss, but the position is long at the bottom for a fraction of the dollars If the stock jumps, the trader can start to write calls for positive theta

15 Short Duration Positions Time to step in this week and get long? You could be right you could be wrong! What do we know? The market is moving The implied volatility is moving up with it The position is to own Gamma and at a minimum Be flat Vega- This is easy to test

16 Back to the Future Oct 3, 2011

17 Back to the Future Oct 3, 2011

18 Back to the Future Nov 3, 2011

19 Back to the Future Nov 3, 2011

20 Executing the Vega Neutral Straddle Why does this work? The volatility products follow the path of IV. When IV jumps, they jump. This allows Vega to be neutralized but have a positive curve

21 October 3 rd, 2011 and Now VIX can get much more Backward than today

22 Executing the Vega Neutral Straddle First identify the market and capital allocation Try to keep the delta of the Volatility product part equal to the Vega of the long gamma part If IV screams, this position will get long more Vega There is almost no negative theta when IV jumps The ideal close is when the one part pays for the other, then unwind the profitable part.

23 Today We have similar position in SPY/VXX in our Strategy Letter we can walk through.

24 Wrapping up Set up Capital Allocation first, before the Bear hits- that means now! Trades in a Bear Market (or declining) has to assume there is more downside to come Long options when structured properly can decay very little or almost not a all Long option positions need to be closedespecially short duration ABC

25 Thank you for attending! 1(888) Trade-01