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The Incredible Winning Trade in SVXY


Shorting volatility via different products like SVXY or XIV has been a very popular and profitable strategy in the last few years. We know what happened on February 5. VIX spiked over 100%, causing a complete collapse of SVXY and XIV, wiping billions of dollars.

Background

Shorting volatility proved to be very profitable historically. The reason is that VIX futures are drifting lower over time, so all you have to do is being short a product that is long volatility (like VXX) or being long an inverse product (like SVXY). Looking at VXX historical chart tells the whole story:

VXX-hist-560x404.jpg

So what's the catch? Well, the issue with going short VXX (or being long SVXY) is those occasional big spikes, like the one in 2008. So the trick is to find a strategy that goes short VXX or long SVXY, but at the same time, doesn't lose much during those occasional spikes.

 

This article tells the story of an incredible SVXY trade that was a big winner despite the total collapse of SVXY.

Few months ago, SteadyOptions introduced a new strategy called PureVolatility. The portfolio is managed by  our veteran member and mentor, Scott Batchelar. Here is an extract from the strategy introduction:

Strategy Description


We will be looking to hold constant exposure to short volatility while the curve is in significant Contango in an effort to harvest volatility premium. We will also look to go long volatility when the curve is in significant Backwardation and indicators reveal the trend will continue in the short term.  Because the curve is in Contango approximately 80% of the time, we will hold short exposure to volatility most of the time.  The main strategy to gain this exposure will be through a Collar spread.


The PureVolatility model portfolio will be based on total capital amount of $10,000 with a 5% allocation on risk.  This is very important as those who are trading in a Reg-T account would on average need $10,000 in initial margin to hold the position even though the risk may only be $500.  Portfolio Margin accounts would only require the $500 max loss amount.  Reg-T is somewhat antiquated when it comes to margin for a Collar spread. However, this really should not be an issue because if one does not have $10,000 to put aside for this strategy it is probably not appropriate.  Furthermore, the increased margin amount will keep members from over allocating to this very aggressive strategy.  We will target a risk reward of better than 1:1 for a two week holding period. 

Here is an example of the Hedged Collar strategy sized for the model portfolio:

  • 100 shares of SVXY at 101.93
  • Short 1 contract of the 11/10 110 Call at (1.35)
  • Long 1 contract of the 11/10 103 Put at 5.54


Using the above example, here is the P/L chart of the trade:

image.png

Please note that the profit potential is around $400 and risk around $300. 

For a strategy that wins around 80% of the time, this is an incredible risk/reward.

But it gets even better.


One of our other veteran members posted the following comment on the forum:
 

Quote

I agree with the trade rationale, but had a thought about a tweak to improve the trade structure that I wonder if you considered - that is replacing the 100 shares of SVXY with a deep ITM call, 90 delta or more.   I see two main benefits.

  1. Significantly lower the capital requirement while maintaining basically the same dollar increases when the SVXY rises since the deep ITM call will grow in value almost as quick as being long the SVXY shares.  
  2. In the event of a large volatility spike where the SVXY would drop in value very quickly, the deep ITM calls would hit a point where they are losing less than the SVXY shares (as that deep ITM strike gets closer to ATM its delta would decrease).  


After some discussion, it has been decided to modify the trade and use deep ITM calls instead of the shares.

Here is an SVXY "modified" collar entered on January 30 with SVXY at 114:
 

Quote

I opened a new collar but I'm holding off on selling the call:

  • BTO 1 March 16, 2018 70 Call
  • BTO 1 March 16, 2018 110 Put


P/L chart:

image.png

Please notice how using ITM calls instead of shares allows to reduce the risk if the stock makes a big down move.

The next day SVXY moved higher and short call has been added.

image.png

On February 2 SVXY started to move down. By the end of the day on February 5, SVXY went down around 40%. After few adjustments the P/L chart looked like this:

image.png

The trade was down $750 or 7.5% loss on $10,000. This is completely reasonable, considering that the underlying was down 40%. Any bounce to $90 area should bring the trade back to breakeven.

But then black Tuesday came. SVXY opened around $11, 60% down. The calls became nearly worthless, but the puts were the big winners, far outpacing the losses in the calls:

image.png

 

Overall this trade produced almost 45% gain on margin or 26% gain on $10,000 portfolio.

 

The bottom line:

A trade that was long SVXY, was a big winner after SVXY went down 90%+. This is options trading at its best. And this is the power of our trading community.

Read the full description of the PureVolatility strategy here.

Related articles:

Edited by Kim

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Hi Kim, one note - why did you create so complicated position as collar or deep ITM call (buy) + ATM call (sell) + ATM put (buy). Instead of that, it would be easy to open credit put spread:  something like sell 110 put/ but 103 put? In other words: covered call or ITM call (buy) + ATM call (sell) == selling uncovered put. Credit put spread requires less commisions, has same margin, and easy to manage

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15 hours ago, vasis said:

Hi Kim, one note - why did you create so complicated position as collar or deep ITM call (buy) + ATM call (sell) + ATM put (buy). Instead of that, it would be easy to open credit put spread:  something like sell 110 put/ but 103 put? In other words: covered call or ITM call (buy) + ATM call (sell) == selling uncovered put. Credit put spread requires less commisions, has same margin, and easy to manage

Hi Vasis, Kim asked me to respond to your question.  There are many differences between the modified Collar and a bull put spread.  In addition to nuances related to implied volatility and being more flexible for adjustments, the major difference is a change in Delta.  With the modified Collar (using ITM options instead of shares) in a large drawdown the position actually goes from negative Delta to positive as the gains from the long put begin to outweigh the losses on the long call and ultimately the position can become profitable.  This was proven in the SVXY meltdown of February as the position ended with a gain of over 100% on risk whereas your Bull put spread would have resulted in a 100% loss on risk.

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Hi SBathch and Kim.

Thanks for reply and your explanation. I agree that credit put spread is different from modified Collar, but its absolutely the same as your original approach. Credit bull spread can be also modified buying far OTM Put (in your case 70 strike), something like -110 put + 103 put +70 put. 

Another question about replacing shares with ITM call (or adding OTM Put in my case) - do you think its reasonable in long term? It adds negative teta to the profile plus if you look at volatile skew you will see the IV on that strike is pretty high (for both call and put), so we are buying overvalued option. Yes, it helps in case of market crashes, but it happens 1 time per year (or rare) in average and it seems to me the hedging cost is too high. 

At the same time original scheme is rationale, has limited risk, and makes sense to me - thanks for sharing it. 

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3 minutes ago, vasis said:

Hi SBathch and Kim.

Thanks for reply and your explanation. I agree that credit put spread is different from modified Collar, but its absolutely the same as your original approach. Credit bull spread can be also modified buying far OTM Put (in your case 70 strike), something like -110 put + 103 put +70 put. 

Another question about replacing shares with ITM call (or adding OTM Put in my case) - do you think its reasonable in long term? It adds negative teta to the profile plus if you look at volatile skew you will see the IV on that strike is pretty high (for both call and put), so we are buying overvalued option. Yes, it helps in case of market crashes, but it happens 1 time per year (or rare) in average and it seems to me the hedging cost is too high. 

At the same time original scheme is rationale, has limited risk, and makes sense to me - thanks for sharing it. 

The negative Theta and IV effect are almost non-existent when using a 95+ Delta option.

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7 minutes ago, vasis said:

Hi SBathch and Kim.

Thanks for reply and your explanation. I agree that credit put spread is different from modified Collar, but its absolutely the same as your original approach. Credit bull spread can be also modified buying far OTM Put (in your case 70 strike), something like -110 put + 103 put +70 put. 

Another question about replacing shares with ITM call (or adding OTM Put in my case) - do you think its reasonable in long term? It adds negative teta to the profile plus if you look at volatile skew you will see the IV on that strike is pretty high (for both call and put), so we are buying overvalued option. Yes, it helps in case of market crashes, but it happens 1 time per year (or rare) in average and it seems to me the hedging cost is too high. 

At the same time original scheme is rationale, has limited risk, and makes sense to me - thanks for sharing it. 

A deep in the money call = a far out of the money put (assuming same strike), for IV purposes.

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6 minutes ago, SBatch said:

The negative Theta and IV effect are almost non-existent when using a 95+ Delta option.

Its the same as just buying far OTM options (lottery ticket) and hope to win. You can do backtest to check that it doesn't make sense.  

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6 minutes ago, SBatch said:

The negative Theta and IV effect are almost non-existent when using a 95+ Delta option.

Yes...deltas in the "90's" have very little extrinsic value.

Also, the IV basically can only go up.

If the market goes up, then the deep in the money call ( far out of the money put) will become even more out of the money to the downside, which increases IV through the skew.

If the market goes down, then in most cases, IV will go up.

So strikes, very far away on the the downside, will have their IV increase in either case.

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4 minutes ago, cuegis said:

A deep in the money call = a far out of the money put (assuming same strike), for IV purposes.

Absolutely, and these options overvalued what volatility skew reflects

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15 minutes ago, vasis said:

Its the same as just buying far OTM options (lottery ticket) and hope to win. You can do backtest to check that it doesn't make sense.  

No it's not, not even close.  At .95+ Delta we pay essentially no extrinsic value, whereas OTM options are all extrinsic.  Therefore, the extrinsic value can increase (if the underlying moves away) but not really decrease because we close about one month before expiration.  We are using a inverted Collar on VXX currently.  Look at the April 105 put - the mid currently is 63.45 and the intrinsic value is 63.23.  That is a whopping .003% of extrinsic value, most of which will be retained by the time the trade is closed.  It has no impact.  Furthermore, it doesn't take a crash to begin to gain.  If we get a drawdown of 20% (very common) the extrinsic begins to increase and so does the IV which now benefits the trade as the Delta has diminished.

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As already mentioned "A deep in the money call = a far out of the money put", otherwise it can be an option for arbitrage. VXX 105 call has the same intrinsic value and 105 put - yes, its pretty small, but not 0. No difference what you are buying: underlying + OTM put or deep-in the money call. 

The extrinsic value decays in both cases - OTM put or ITM call and since its far from central strike the speed of decay became slow reaching expiration (so almost no impact that you are closing the position one month before expiration) 

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45 minutes ago, vasis said:

As already mentioned "A deep in the money call = a far out of the money put", otherwise it can be an option for arbitrage. VXX 105 call has the same intrinsic value and 105 put - yes, its pretty small, but not 0. No difference what you are buying: underlying + OTM put or deep-in the money call. 

The extrinsic value decays in both cases - OTM put or ITM call and since its far from central strike the speed of decay became slow reaching expiration (so almost no impact that you are closing the position one month before expiration) 

Yes I am well aware of everything you posted here, what’s your point?  I answered your original question about how the modified  Collar is different than the bull  put spread.  You then told me I need to do more backtesting because of how the Theta and IV were going to hurt the trade.  I illustrated to you how that is completely false.  Now you are giving me a lesson on how a deep ITM call equals a far OTM put (which I am already aware of and it has no real world bearing or practical implications on this trade’s performance).

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Yes, thanks for your answer, I'm not trying to study you and I said at the beginning that original scheme makes sense to me. I don't see the value to add one more option (replacing shares with ITM). For me it reduces the profit in the long term, but yes - helps to fight when market crashes. It's your choice - no doubts

And one more thing: "No it's not, not even close.  At .95+ Delta we pay essentially no extrinsic value, whereas OTM options are all extrinsic." The reality is that extrinsic value is the same for ITM and OTM.

That's all. And please excuse if my posts looks aggressive or mentoring - they are really not. SteadyOptions is one of the best materials about options which I ever seen.

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5 minutes ago, vasis said:

Yes, thanks for your answer, I'm not trying to study you and I said at the beginning that original scheme makes sense to me. I don't see the value to add one more option (replacing shares with ITM). For me it reduces the profit in the long term, but yes - helps to fight when market crashes. It's your choice - no doubts

And one more thing: "No it's not, not even close.  At .95+ Delta we pay essentially no extrinsic value, whereas OTM options are all extrinsic." The reality is that extrinsic value is the same for ITM and OTM.

That's all. And please excuse if my posts looks aggressive or mentoring - they are really not. SteadyOptions is one of the best materials about options which I ever seen.

Yes the extrinsic is the same on both but you are missing the bigger picture which is how it impacts the trade. This is what I was referring to by saying they were totally different.  I am speaking in terms of reality not academia as reality is what matters. If the underlying moves against the trade the losses are diminished as the Delta declines while the shares take the full loss.  At this time the trade can be adjusted back to a 95+ Delta option to recapture 95%+ of the gains on the mean reversion which would increase returns.  These types of adjustments are made frequently.  In addition the margin requirement is lower using ITM options.  Therefore at a cost of less than 1% per year the trade has the ability to profit in a huge vol spike, loses less in a moderate to high vol spike, is more flexible for adjustments which enhance returns and requires less margin (which could be deployed elsewhere to more than make up the 1% annual hedge cost).  This is what I meant by saying they were totally different.  The extrinsic value may be the same but the trade implications are totally different.

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1 hour ago, SBatch said:

Yes the extrinsic is the same on both but you are missing the bigger picture which is how it impacts the trade. This is what I was referring to by saying they were totally different.  I am speaking in terms of reality not academia as reality is what matters. If the underlying moves against the trade the losses are diminished as the Delta declines while the shares take the full loss.  At this time the trade can be adjusted back to a 95+ Delta option to recapture 95%+ of the gains on the mean reversion which would increase returns.  These types of adjustments are made frequently.  In addition the margin requirement is lower using ITM options.  Therefore at a cost of less than 1% per year the trade has the ability to profit in a huge vol spike, loses less in a moderate to high vol spike, is more flexible for adjustments which enhance returns and requires less margin (which could be deployed elsewhere to more than make up the 1% annual hedge cost).  This is what I meant by saying they were totally different.  The extrinsic value may be the same but the trade implications are totally different.

OK, a couple of clarifying questions. Let simplify our SVXY position to the ITM Call 70 vs. SVXY + OTM Put 70. Did I get you right that you see a difference between them from P&L perspective (they have same extrinsic value and let forget about margin for a while)? If yes, might it be described as a different IV for the call and put on the same strike? 

And the second question - do you see the difference between your full SVXY position: +Call70 + Put103 - Call110 and my proposal: +Put70 + Put103 - Put110?

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The whole point of replacing the shares with deep ITM call is to profit from sharp pullback. If SVXY continues higher, the shares will behave almost like 95% delta call. But when SVXY goes down, the delta of the long calls decreases, so the loss of the calls becomes much smaller than the loss on the shares. At some point if long calls become OTM, the long puts increase in value much more than the long calls lose - this is what allowed this specific trade to make such nice gain after SVXY collapse. It would never be possible with "standard" collar.

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Hi Kim,

Yes, the idea of replacing shares with ITM option is pretty clear - you are buying the additional hedge which helps to mitigate/reduce the risk. In my opinion, it's not required, but if you want to have smooth profit curve - it might be OK. SBatch mentioned that cost is low enough and I'd agree here - it's your strategy.  Let close this part.

My question was different - SBatch mentioned that buying ITM call is better than OTM put + underlying (practically, you can build the inverse one: shares - OTM call (covered call) vs naked put).  

"Yes the extrinsic is the same on both but you are missing the bigger picture which is how it impacts the trade." Or "The extrinsic value may be the same but the trade implications are totally different".

For me, there is no difference at all what position to open (no touch commisions or margin): ITM call or shares + OTM put (same strike) OR shares - OTM call vs -ITM put. If you or SBatch can give real examples when it matters - it would be great. A couple of times I saw the situations with NUGT and DUST when IV calls was not equal to IV of puts on the same strikes - but it might be terminal issues.

If you agree with my statement about ITM/OTM - wonderful, all questions have been answered. From commision/margin/management point of view, you can use ITM or OTM according to the situation (spread, etc.) 

 

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17 minutes ago, vasis said:

Hi Kim,

Yes, the idea of replacing shares with ITM option is pretty clear - you are buying the additional hedge which helps to mitigate/reduce the risk. In my opinion, it's not required, but if you want to have smooth profit curve - it might be OK. SBatch mentioned that cost is low enough and I'd agree here - it's your strategy.  Let close this part.

My question was different - SBatch mentioned that buying ITM call is better than OTM put + underlying (practically, you can build the inverse one: shares - OTM call (covered call) vs naked put).  

"Yes the extrinsic is the same on both but you are missing the bigger picture which is how it impacts the trade." Or "The extrinsic value may be the same but the trade implications are totally different".

For me, there is no difference at all what position to open (no touch commisions or margin): ITM call or shares + OTM put (same strike) OR shares - OTM call vs -ITM put. If you or SBatch can give real examples when it matters - it would be great. A couple of times I saw the situations with NUGT and DUST when IV calls was not equal to IV of puts on the same strikes - but it might be terminal issues.

If you agree with my statement about ITM/OTM - wonderful, all questions have been answered. From commision/margin/management point of view, you can use ITM or OTM according to the situation (spread, etc.) 

 

I never said buying an ITM call was better than OTM put plus the underlying.  Your question was regarding an OTM credit spread plus a put with no shares.  Your example was -110 put + 103 put +70 put.  That is the example I was referring to, nothing that included shares/ITM options.

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Aha, got it. Let consider your position +Call70 + Put103 - Call110 vs +Put70 + Put103 - Put110. Do you see any difference? We can even simplify it to +Call70 - Call110 vs +Put70 - Put110. 

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Yes, the difference is I often stagger the long put and short call with regard to expiration based upon IV.  With lower IV of the underlying I will hold the long put out 3 weeks as it is less expensive to purchase and will benefit more with a spike in IV while I will keep the short call out 1-2 weeks in that environment.

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IV is the same on the same strikes for puts and calls, you don't have any benefits from puts vs calls (or vice verse) even when volatility spikes. Even the margin requirements are/should be the same either (at least if your broker has proper soft).  Kim, are you agree? 

You can play with P&L graphs over the time (using any stocks or ETF or commodities). Time to expiration doesn't matter here.

When you have different IV for calls and puts you can do arbitrage (buy shares - call_strike1 + put_strike_1 = some risk-free credits at expiration). 

 

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31 minutes ago, vasis said:

IV is the same on the same strikes for puts and calls, you don't have any benefits from puts vs calls (or vice verse) even when volatility spikes. Even the margin requirements are/should be the same either (at least if your broker has proper soft).  Kim, are you agree? 

You can play with P&L graphs over the time (using any stocks or ETF or commodities). Time to expiration doesn't matter here.

When you have different IV for calls and puts you can do arbitrage (buy shares - call_strike1 + put_strike_1 = some risk-free credits at expiration). 

 

At this time I am going to ask you to refrain from giving me any further lectures on option theory.  I am not referring to put/call parity but rather to buying further dated options when IV is low and buying closer dated options when IV is high, this leads to staggering between the short and long at times and acts as additional protection in IV spikes when the underlying moves against the position and protects against IV crush if initiated during a spike in IV.  It also allows me to sell multiple iterations of the short against the same long.  Selling each week generates a greater credit than selling multiple weeks out and allows for more flexibility on strike selection.  This all has proven to be very beneficial over the course of the last two months on the model portfolio trade.  All that being said, based upon this  discourse it seems it is probably best that you pursue your own strategy.  Best of luck.

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Are you seriously still talking about this?

My email box has been flooded for the past 24 hours with posts about this topic.

I amazed that this is still being discussed.

In my opinion, this was put to rest 27 posts ago.

Why are you still talking about about it?

I'm shutting down any further alerts from this topic, as it is flooding my email box, and I would think that the majority of you would agree, that it has passed any degree of usefulness 12 hours ago.

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4 minutes ago, cuegis said:

Are you seriously still talking about this?

My email box has been flooded for the past 24 hours with posts about this topic.

I amazed that this is still being discussed.

In my opinion, this was put to rest 27 posts ago.

Why are you still talking about about it?

I'm shutting down any further alerts from this topic, as it is flooding my email box, and I would think that the majority of you would agree, that it has passed any degree of usefulness 12 hours ago.

I have an obligation as a Mentor to respond to a member’s questions and misinformation, believe me I’m no more interested in this impossible discourse than you are.

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17 minutes ago, SBatch said:

I have an obligation as a Mentor to respond to a member’s questions and misinformation, believe me I’m no more interested in this impossible discourse than you are.

I understand. I praise you for your patience.

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7 hours ago, SBatch said:

At this time I am going to ask you to refrain from giving me any further lectures on option theory.  I am not referring to put/call parity but rather to buying further dated options when IV is low and buying closer dated options when IV is high, this leads to staggering between the short and long at times and acts as additional protection in IV spikes when the underlying moves against the position and protects against IV crush if initiated during a spike in IV.  It also allows me to sell multiple iterations of the short against the same long.  Selling each week generates a greater credit than selling multiple weeks out and allows for more flexibility on strike selection.  This all has proven to be very beneficial over the course of the last two months on the model portfolio trade.  All that being said, based upon this  discourse it seems it is probably best that you pursue your own strategy.  Best of luck.

4

Thanks, bye

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Look good trade to me. The idea of having the tail risk up-side is great. Quick Questions:

1. This Strategy would be effectively very similar to going short a put spread. In your first example it would be:

  • Short 1 contract of the 11/10 110 Put 
  • Long 1 contract of the 11/10 103 Put 

This trade will not have the tail risk gain but would have a pretty nice increase on the maximum gain compare to the synthetic collar since the collar spend some premiums on the ITM Calls to replicate the move of underlying. 

What do you think the trade-off?

2. Even this is a limit gain/loss strategy, do we have a exit plan if market move against us? or we just leave the trade free of touch?

Again love this idea so much. It's a good ( and most importantly, safe) way to dance with the VIX curve.


Best,

 

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  1. Generally speaking, the standard collar P/L is similar to debit spread. But there are some nuances. But the main difference is that we are using deep ITM calls to handle cases exactly like this one, and this makes a HUGE difference. The synthetic collar uses deep ITM calls which have very little time value and are also few weeks away, so we are losing very little compared to using the stock.
  2. The trade is constantly adjusted based on market conditions.

 

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