138 lines
32 KiB
Plaintext
138 lines
32 KiB
Plaintext
CHAPTER 16
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Ratio Spreads and Complex Spreads
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The purpose of spreading is to reduce risk. Buying one contract and selling another can reduce some or all of a trade’s risks, as measured by the greeks, compared with simply holding an outright option. But creative traders have the ability to exercise great control over their greeks risk. They can practically eliminate risk in some greeks, while retaining risks in just the desired greeks. To do so, traders may have to use more complex, and less conventional spreads. These spreads often involve buying or selling options in quantities other than one-to-one ratios.
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Ratio Spreads
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The simplest versions of these strategies used by retail traders, institutional traders, proprietary traders, and others are referred to as
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ratio spreads
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. In ratio spreads, options are bought and sold in quantities based on a ratio. For example, a 1:3 spread is when one option is bought (or sold) and three are sold (or bought)—a ratio of one to three. This kind of ratio spread would be called a “one-by-three.”
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However, some option positions can get a lot more complicated. Market makers and other professional traders manage a complex inventory of long and short options. These types of strategies go way beyond simple at-expiration diagrams. This chapter will discuss the two most common types of ratio spreads—backspreads and ratio vertical spreads—and also the delta-neutral position management of market makers and other professional traders.
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Backspreads
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Definition
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: An option strategy consisting of more long options than short options having the same expiration month. Typically, the trader is long calls (or puts) in one series of options and short a fewer number of calls (or puts) in another series with the same expiration month in the same option class. Some traders, such as market makers, refer generically to any delta-neutral long-gamma position as a backspread.
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Shades of Gray
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In its simplest form, trading a backspread is trading a one-by-two call or put spread and holding it until expiration in hopes that the underlying stock’s price will make a big move, particularly in the more favorable direction. But holding a backspread to expiration as described has its challenges. Let’s look at a hypothetical example of a backspread held to term and its at-expiration diagram.
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With the stock at $71 and one month until March expiration:
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In this example, there is a credit of 3.20 from the sale of the 70 call and a debit of 1.10 for each of the two 75 calls. This yields a total net credit of 1.00 (3.20 − 1.10 − 1.10). Let’s consider how this trade performs if it is held until expiration.
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If the stock falls below $70 at expiration, all the calls expire and the 1.00 credit is all profit. If the stock is between $70 and $75 at expiration, the 70 call is in-the-money (ITM) and the −1.00 delta starts racking up losses above the breakeven of $71 (the strike plus the credit). At $75 a share this trade suffers its maximum potential loss of $4. If the stock is above $75 at expiration, the 75 calls are ITM. The net delta of +1.00, resulting from the +2.00 deltas of the 75 calls along with the −1.00 delta of the 70 call, makes money as the stock rises. To the upside, the trade is profitable once the stock is at a high enough price for the gain on the two 75 calls to make up for the loss on the 70 call. In this case, the breakeven is $79 (the $4 maximum potential loss plus the strike price of 75).
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While it’s good to understand this at-expiration view of this trade, this diagram is a bit misleading. What does the trader of this spread want to have happen? If the trader is bearish, he could find a better way to trade his view than this, which limits his gains to 1.00—he could buy a put. If the trader believes the stock will make a volatile move in either direction, the backspread offers a decidedly limited opportunity to the downside. A straddle or strangle might be a better choice. And if the trader is bullish, he would have to be very bullish for this trade to make sense. The underlying needs to rise above $79 just to break even. If instead he just bought 2 of the 75 calls for 1.10, the maximum risk would be 2.20 instead of 4, the breakeven would be $77.20 instead of $79, and profits at expiration would rack up twice as fast above the breakeven, since the trader is net long two calls instead of one. Why would a trader ever choose to trade a backspread?
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EXHIBIT 16.1
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Backspread at expiration.
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The backspread is a complex spread that can be fully appreciated only when one has a thorough knowledge of options. Instead of waiting patiently until expiration, an experienced backspreader is more likely to gamma scalp intermittent opportunities. This requires trading a large enough position to make scalping worthwhile. It also requires appropriate margining (either professional-level margin requirements or retail portfolio margining). For example, this 1:2 contract backspread has a delta of −0.02 and a gamma of +0.05. Fewer than 10 deltas could be scalped if the stock moves up and down by one point. It becomes a more practical trade as the position size increases. Of course, more practical doesn’t necessarily guarantee it will be more profitable. The market must cooperate!
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Backspread Example
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Let’s say a 20:40 contract backspread is traded. (
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Note
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: In trader lingo this is still called a one-by-two; it is just traded 20 times.) The spread price is still 1.00 credit per contract; in this case, that’s $2,000. But with this type of trade, the spread price is not the best measure of risk or reward, as it is with some other kinds of spreads. Risk and reward are best measured by delta, gamma, theta, and vega.
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Exhibit 16.2
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shows this trade’s greeks.
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EXHIBIT 16.2
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Greeks for 20:40 backspread with the underlying at $71.
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Backspreads are volatility plays. This spread has a +1.07 vega with the stock at $71. It is, therefore, a bullish implied volatility (IV) play. The IV of the long calls, the 75s, is 30 percent, and that of the 70s is 32 percent. Much as with any other volatility trade, traders would compare current implied volatility with realized volatility and the implied volatility of recent past and consider any catalysts that might affect stock volatility. The objective is to buy an IV that is lower than the expected future stock volatility, based on all available data. The focus of traders of this backspread is not the dollar credit earned. They are more interested in buying a 30 volatility—that’s the focus.
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But the 75 calls’ IV is not the only volatility figure to consider. The short options, the 70s, have implied volatility of 32 percent. Because of their lower strike, the IV is naturally higher for the 70 calls. This is vertical skew and is described in Chapter 3. The phenomenon of lower strikes in the same option class and with the same expiration month having higher IV is very common, although it is not always the case.
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Backspreads usually involve trading vertical skew. In this spread, traders are buying a 30 volatility and selling a 32 volatility. In trading the skew, the traders are capturing two volatility points of what some traders would call edge by buying the lower volatility and selling the higher.
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Based on the greeks in
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Exhibit 16.2
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, the goal of this trade appears fairly straightforward: to profit from gamma scalping and rising IV. But, sadly, what appears to be straightforward is not.
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Exhibit 16.3
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shows the greeks of this trade at various underlying stock prices.
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EXHIBIT 16.3
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70–75 backspread greeks at various stock prices.
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Notice how the greeks change with the stock price. As the stock price moves lower through the short strike, the 70 strike calls become the more relevant options, outweighing the influence of the 75s. Gamma and vega become negative, and theta becomes positive. If the stock price falls low enough, this backspread becomes a very different position than it was with the stock price at $71. Instead of profiting from higher implied and realized volatility, the spread needs a lower level of both to profit.
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This has important implications. First, gamma traders must approach the backspread a little differently than they would most spreads. The backspread traders must keep in mind the dynamic greeks of the position. With a trade like a long straddle, in which there are no short options, traders scalping gamma simply buy to cover short deltas as the stock falls and sell to cover long deltas as the stock rises. The only risks are that the stock may not move enough to cover theta or that the traders may cover deltas too soon to maximize profits.
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With the backspread, the changing gamma adds one more element of risk. In this example, buying stock to flatten out delta as the stock falls can sometimes be a premature move. Traders who buy stock may end up with more long deltas than they bargained for if the stock falls into negative-gamma territory.
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Exhibit 16.3
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shows that with the stock at $68, the delta for this trade is −2.50. If the traders buy 250 shares at $68, they will be delta neutral. If the stock subsequently falls to $62 a share, instead of being short 1.46 deltas, as the figure indicates, they will be long 1.04 because of the 250 shares they bought. These long deltas start to hurt as the stock continues lower. Backspreaders must therefore anticipate stock movements to avoid overhedging. The traders in this example may decide to lean short if the stock shows signs of weakness.
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Leaning short means that if the delta is −2.50 at $68 a share, the traders may decide to underhedge by buying just 100 or 200 shares. If the stock continues to fall and negative gamma kicks in, this gives the traders some cushion to the downside. The short delta of the position moves closer to being flat as the stock falls. Because there is a long strike and a short strike in this delta-neutral position, trading ratio spreads is like trading a long and a short volatility position at the same time. Trading backspreads is not an exact science. The stock has just as good a chance of rising as it does of falling, and if it does rise and the traders have underhedged at $68, they will not participate in all the gains they would have if they had fully hedged by buying 250 shares of stock. If trading were easy, everyone would do it!
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Backspreaders must also be conscious of the volatility of each leg of the spread. There is an inherent advantage in this example to buying the lower volatility of the 75 calls and selling the higher volatility of the 70 calls. But there is also implied risk. Equity prices and IV tend to have an inverse relationship. When stock prices fall—especially if the drop happens quickly—IV will often rise. When stock prices rise, IV often falls.
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In this backspread example, as the stock price falls to or through the short strike, vega becomes negative in the face of a potentially rising IV. As the stock price rises into positive vega turf, there is the risk of IV’s declining. A dynamic volatility forecast should be part of a backspread-trading plan. One of the volatility questions traders face in this example is whether the two-point volatility skew between the two strike prices is enough to compensate for the potential adverse vega move as the stock price changes.
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Put backspreads have the opposite skew/volatility issues. Buying two lower-strike puts against one higher-strike put means the skew is the other direction—buying the higher IV and selling the lower. The put backspread would have long gamma/vega to the downside and short gamma/vega to the upside. But if the vega firms up as the stock falls into positive-vega territory, it would be in the trader’s favor. As the stock rises, leading to negative vega, there is the potential for vega profits if IV indeed falls. There are a lot of things to consider when trading a backspread. A good trader needs to think about them all before putting on the trade.
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Ratio Vertical Spreads
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Definition
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: An option strategy consisting of more short options than long options having the same expiration month. Typically, the trader is short calls (or puts) in one series of options and long a fewer number of calls (or puts) in another series in the same expiration month on the same option class.
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A ratio vertical spread, like a backspread, involves options struck at two different prices—one long strike and one short. That means that it is a volatility strategy that may be long or short gamma or vega depending on where the underlying price is at the time. The ratio vertical spread is effectively the opposite of a backspread. Let’s study a ratio vertical using the same options as those used in the backspread example.
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With the stock at $71 and one month until March expiration:
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In this case, we are buying one ITM call and selling two OTM calls. The relationship of the stock price to the strike price is not relevant to whether this spread is considered a ratio vertical spread. Certainly, all these options could be ITM or OTM at the time the trade is initiated. It is also not important whether the trade is done for a debit or a credit. If the stock price, time to expiration, volatility, or number of contracts in the ratio were different, this could just as easily been a credit ratio vertical.
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Exhibit 16.4
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illustrates the payout of this strategy if both legs of the 1:2 contract are still open at expiration.
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EXHIBIT 16.4
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Short ratio spread at expiration.
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This strategy is a mirror image of the backspread discussed previously in this chapter. With limited risk to the downside, the maximum loss to the trade is the initial debit of 1 if the stock is below $70 at expiration and all the calls expire. There is a maximum profit potential of 4 if the stock is at the short strike at expiration. There is unlimited loss potential, since a short net delta is created on the upside, as one short 75 call is covered by the long 70 call, and one is naked. The breakevens are at $71 and $79.
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Low Volatility
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With the stock at $71, gamma and vega are both negative. Just as the backspread was a long volatility play at this underlying price, this ratio vertical is a short-vol play here. As in trading a short straddle, the name of the game is low volatility—meaning both implied and realized.
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This strategy may require some gamma hedging. But as with other short volatility delta-neutral trades, the fewer the negative scalps, the greater the potential profit. Delta covering should be implemented in situations where it looks as if the stock will trend deep into negative-gamma territory. Murphy’s Law of trading dictates that delta covering will likely be wrong at least as often as it is right.
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Ratio Vertical Example
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Let’s examine a trade of 20 contracts by 40 contracts.
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Exhibit 16.5
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shows the greeks for this ratio vertical.
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EXHIBIT 16.5
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Short ratio vertical spread greeks.
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Before we get down to the nitty-gritty of the mechanics and management of this trade—the how—let’s first look at the motivations for putting the trade on—the why. For the cost of 1.00 per spread, this trader gets a leveraged position if the stock rises moderately. The profits max out with the stock at the short-strike target price—$75—at expiration.
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Another possible profit engine is IV. Because of negative vega, there is the chance of taking a quick profit if IV falls in the interim. But short-term losses are possible, too. IV can rise, or negative gamma can hurt the trader. Ultimately, having naked calls makes this trade not very bullish. A big move north can really hurt.
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Basically, this is a delta-neutral-type short-volatility play that wins the most if the stock is at $75 at expiration. One would think about making this trade if the mechanics fit the forecast. If this trader were a more bullish than indicated by the profit and loss diagram, a more-balanced bull call spread would be a better strategy, eliminating the unlimited upside risk. If upside risk were acceptable, this trader could get more aggressive by trading the spread one-by-three. That would result in a credit of 0.05 per spread. There would then be no ultimate risk below $70 but rather a 0.05 gain. With double the naked calls, however, there would be double punishment if the stock rallied strongly beyond the upside breakeven.
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Ultimately, mastering options is not about mastering specific strategies. It’s about having a thorough enough understanding of the instrument to be flexible enough to tailor a position around a forecast. It’s about minimizing the unwanted risks and optimizing exposure to the intended risks. Still, there always exists a trade-off in that where there is the potential for profit, there is the possibility of loss—you can always be wrong.
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Recalling the at-expiration diagram and examining the greeks, the best-case scenario is intuitive: the stock at $75 at expiration. The biggest theta would be right at that strike. But that strike price is also the center of the biggest negative gamma. It is important to guard against upward movement into negative delta territory, as well as movement lower where the position has a slightly positive delta.
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Exhibit 16.6
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shows what happens to the greeks of this trade as the stock price moves.
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EXHIBIT 16.6
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Ratio vertical spread at various prices for the underlying.
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As the stock begins to rise from $71 a share, negative deltas grow fast in the short term. Careful trend monitoring is necessary to guard against a rally. The key, however, is not in knowing what will happen but in skillfully hedging against the unknown. The talented option trader is a disciplined risk manager, not a clairvoyant.
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One of the risks that the trader willingly accepted when placing this trade was short gamma. But when the stock moves and deltas are created, decisions have to be made. Did the catalyst(s)—if any—that contributed to the rise in stock price change the outlook for volatility? If not, the decision is simply whether or not to hedge by buying stock. However, if it appears that volatility is on the rise, it is not just a delta decision. A trader may consider buying some of the short options back to reduce volatility exposure.
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In this example, if the stock rises and it’s feared that volatility may increase, a good choice may be to buy back some of the short 75-strike calls. This has the advantage of reducing delta (buy enough deltas to flatten out) and reducing gamma and vega. Of course, the downside to this strategy is that in purchasing the calls, a loss is likely to be locked in. Unless a lot of time has passed or implied volatility has dropped sharply, the calls will probably be bought at a higher price than they were sold.
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If the stock makes a violent move upward, a loss will be incurred. Whether this loss is locked in by closing all or part of the position, the account will still be down in value. The decision to buy the calls back at a loss is based on looking forward. Nothing good can come of looking back.
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How Market Makers Manage Delta-Neutral Positions
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While market makers are not position traders per se, they are expert position managers. For the most part, market makers make their living by buying the bid and selling the offer. In general, they don’t act; they react. Most of their trades are initiated by taking the other side of what other people want to do and then managing the risk of the positions they accumulate.
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The business of a market maker is much like that of a casino. A casino takes the other side of people’s bets and, in the long run, has a statistical (theoretical) edge. For market makers, because theoretical value resides in the middle of the bid and the ask, these accommodating trades lead to a theoretical profit—that is, the market maker buys below theoretical value and sells above. Actual profit—cold, hard cash you can take to the bank—is, however, dependent on sound management of the positions that are accumulated.
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My career as a market maker was on the floor of the Chicago Board Options Exchange (CBOE) from 1998 to 2005. Because, over all, the trades I made had a theoretical edge, I hoped to trade as many contracts as possible on my markets without getting too long or too short in any option series or any of my greeks.
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As a result of reacting to order flow, market makers can accumulate a large number of open option series for each class they trade, resulting in a single position. For example,
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Exhibit 16.7
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shows a position I had in Ford Motor Co. (F) options as a market maker.
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EXHIBIT 16.7
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Market-maker position in Ford Motor Co. options.
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With all the open strikes, this position is seemingly complex. There is not a specific name for this type of “spread.” The position was accumulated over a long period of time by initiating trades via other traders selling options to me at prices I wanted to buy them—my bid—and buying options from me at prices I wanted to sell them—my offer. Upon making an option trade, I needed to hedge directional risk immediately. I usually did so by offsetting my option trades by taking the opposite delta position in the stock—especially on big-delta trades. Through this process of providing liquidity to the market, I built up option-centric risk.
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To manage this risk I needed to watch my other greeks. To be sure, trying to draw a P&L diagram of this position would be a fruitless endeavor.
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Exhibit 16.8
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shows the risk of this trade in its most distilled form.
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EXHIBIT 16.8
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Analytics for market-maker position in Ford Motor Co. (stock at $15.72).
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Delta
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+1,075
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Gamma
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−10,191
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Theta
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+1,708
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Vega
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+7,171
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Rho
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−33,137
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The +1,075 delta shows comparatively small directional risk relative to the −10,191 gamma. Much of the daily task of position management would be to carefully guard against movement by delta hedging when necessary to earn the $1,708 per day theta.
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Much of the negative gamma/positive theta comes from the combined 1,006 short January 15 calls and puts. (Note that because this position is traded delta neutral, the net long or short options at each strike is what matters, not whether the options are calls or puts. Remember that in delta-neutral trading, a put is a call, and a call is a put.) The positive vega stems from the fact that the position is long 1,927 January 2003 20-strike options.
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Although this position has a lot going on, it can be broken down many ways. Having long LEAPS options and short front-month options gives this position the feel of a time spread. One way to think of where most of the gamma risk is coming from is to bear in mind that the 15 strike is synthetically short 503 straddles (1,006 options ÷ two). But this position overall is not like a straddle. There are more strikes involved—a lot more. There is more short gamma to the downside if the price of Ford falls toward $12.50. To the upside, the 17.50 strike is long a combined total of 439 options. Looking at just the 15 and 17.50 strikes, we can see something that looks more like a ratio spread: 1,006:439. If the stock were at $17.50, the gamma would be around +5,000.
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With the stock at $15.72, there is realized volatility risk of F rallying, but with gamma changing from negative to positive as the stock rallies, the risk of movement decreases quickly. The 20 strike is short 871 options which brings the position back to negative-gamma territory. Having alternating long and short strikes, sometimes called a butterflied position, is a handy way for market makers to reduce risk. A position is perfectly butterflied if it has alternating long and short strikes with the same number of contracts.
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Through Your Longs to Your Shorts
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With market-maker-type positions consisting of many strikes, the greatest profit is gained if the underlying security moves through the longs to the shorts. This provides kind of a win-win scenario for greeks traders. In this situation, traders get the benefit of long gamma as the stock moves higher or lower through the long strike. They also reap the benefits of theta when the stock sits at the short strike.
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Trading Flat
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Most market makers like to trade flat—that is, profit from the bid-ask spread and strive to lower exposure to direction, time, volatility, and interest as much as possible. But market makers are at the mercy of customer orders, or paper, as it’s known in the industry. If someone sells, say, the March 75 calls to a market maker at the bid, the best-case scenario is that moments later someone else buys the same number of the same calls—the March 75s, in this case—from that same market maker at the offer. This is locking in a profit.
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Unfortunately, this scenario seldom plays out this way. In my seven years as a market maker, I can count on one hand the number of times the option gods smiled upon me in such a way as to allow me to immediately scalp an option. Sometimes, the same option will not trade again for a week or longer. Very low-volume options trade “by appointment only.” A market maker trading illiquid options may hold the position until it expires, having no chance to get out at a reasonable price, often taking a loss on the trade.
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More typically, if a market maker buys an option, he must sell a different option to lessen the overall position risk. The skills these traders master are to lower bids and offers on options when they are long gamma and/or vega and to raise bids and offers on options when they are short gamma and/or vega. This raising and lowering of markets is done to manage risk.
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Effectively, this is your standard high school economics supply-and-demand curves in living color. When the market demands (buys) all the options that are supplied (offered) at a certain price, the price rises. When the market supplies (sells) all the options demanded (bid) at a price level, the price falls. The catalyst of supply and demand is the market maker and his risk tolerance. But instead of the supply and demand for individual options, it is supply and demand for gamma, theta, and vega. This is trading option greeks.
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Hedging the Risk
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Delta is the easiest risk for floor traders to eliminate quickly. It becomes second nature for veteran floor traders to immediately hedge nearly every trade with the underlying. Remember, these liquidity providers are in the business of buying option bids and selling option offers, not speculating on direction.
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The next hurdle is to trade out of the option-centric risk. This means that if the market maker is long gamma, he needs to sell options; if he’s short gamma, he needs to buy some. Same with theta and vega. Market makers move their bids and offers to avoid being saddled with too much gamma, theta, and vega risk. Experienced floor traders are good at managing option risk by not biting off more than they can chew. They strive to never buy or sell more options than they can spread off by selling or buying other options. This breed of trader specializes in trading the spread and managing risk, not in predicting the future. They’re market makers, not market takers.
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Trading Skew
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There are some trading strategies for which market makers have a natural propensity that stems from their daily activity of maintaining their positions. While money managers who manage equity funds get to know the fundamentals of the stocks they trade very well, options market makers know the volatility of the option classes they trade. When they adjust their markets in reacting to order flow, it’s, mechanically, implied volatility that they are raising or lowering to change theoretical values. They watch this figure very carefully and trade its subtle changes.
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A characteristic of options that many market makers and some other active professional traders observe and trade is the volatility skew. Savvy traders watch the implied volatility of the strikes above the at-the-money (ATM)—referred to as
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calls
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, for simplicity—compared with the strikes below the ATM, referred to as
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puts
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. In most stocks, there typically exists a “normal” volatility skew inherent to options on that stock. When this skew gets out of line, there may be an opportunity.
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Say for a particular option class, the call that is 10 percent OTM typically trades about four volatility points lower than the put that is 10 percent OTM. For example, for a $50 stock, the 55 calls are trading at a 21 IV and the 45 puts are trading at a 25 volatility. If the 45 puts become bid higher, say, nine points above where the calls are offered—for instance, the puts are bid at 32 volatility bid while the calls are offered at 23 vol—a trader can speculate on the skew reverting back to its normal relationship by selling the puts, buying the calls, and hedging the delta by selling the right amount of stock.
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This position—long a call, short a put with a different strike, and short stock on a delta-neutral ratio—is called a risk reversal. The motive for risk reversals is to capture vega as the skew realigns itself. But there are many risk factors that require careful attention.
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First, as in other positions consisting of both long and short strikes, the gamma, theta, and vega of the position will vary from positive to negative depending on the price of the underlying. Risk-reversal traders must be prepared to trade long gamma (and battle time decay) when the stock rallies closer to the long-call strike and trade short gamma (and assume the risk of possible increased realized volatility) when the stock moves closer to the short-put strike.
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As for vega, being short implied volatility on the downside and long on the upside is inherently a potentially bad position whichever way the stock moves. Why? As equities decline in price, the implied volatility of their options tends to rise. But the downside is where the risk reversal has its short vega. Furthermore, as equities rally, their IV tends to fall. That means the long vega of the upside hurts as well.
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When Delta Neutral Isn’t Direction Indifferent
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Many dynamic-volatility option positions, such as the risk reversal, have vega risk from potential IV changes resulting from the stock’s moving. This is indirectly a directional risk. While having a delta-neutral position hedges against the rather straightforward directional risk of the position delta, this hidden risk of stock movement is left unhedged. In some circumstances, a delta-lean can help abate some of the vega risk of stock-price movement.
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Say an option position has fairly flat greeks at the current stock price. Say that given the way this particular position is set up, if the stock rises, the position is still fairly flat, but if the stock falls, short lower-strike options will lead to negative gamma and vega. One way to partially hedge this position is to lean short deltas—that is, instead of maintaining a totally flat delta, have a slightly short delta. That way, if the stock falls, the trade profits some on the short stock to partially offset some of the anticipated vega losses. The trade-off of this hedge is that if the stock rises, the trade loses on the short delta.
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Delta leans are more of an art than a science and should be used as a hedge only by experienced vol traders. They should be one part of a well-orchestrated plan to trade the delta, gamma, theta, and vega of a position. And, to be sure, a delta lean should be entered into a model for simulation purposes before executing the trade to study the up-and-down risk of the position. If the lean reduces the overall risk of the position, it should be implemented. But if it creates a situation where there is an anticipated loss if the stock moves in either direction and there is little hope of profiting from the other greeks, the lean is not the answer—closing the position is.
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Managing Multiple-Class Risk
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Most traders hold option positions in more than one option class. As an aside, I recommend doing so, capital and experience permitting. In my experience, having positions in multiple classes psychologically allows for a certain level of detachment from each individual position. Most traders can make better decisions if they don’t have all their eggs in one basket.
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But holding a portfolio of option positions requires one more layer of risk management. The trader is concerned about the delta, gamma, theta, vega, and rho not only of each individual option class but also of the portfolio as a whole. The trader’s portfolio is actually one big position with a lot of moving parts. To keep it running like a well-oiled machine requires monitoring and maintaining each part to make sure they are working together. To have the individual trades work in harmony with one another, it is important to keep a well-balanced series of strategies.
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Option trading requires diversification, just like conventional linear stock trading or investing. Diversification of the option portfolio is easily measured by studying the portfolio greeks. By looking at the net greeks of the portfolio, the trader can get some idea of exposure to overall risk in terms of delta, gamma, theta, vega, and rho. |