The Incredible Winning Trade in SVXY

Isn't this just a long strangle that uses deep in the money options, rather than the usual out of the money ones?

This was the position on Monday, yes. But not the initial position because the short call was added later and the position was adjusted.

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

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.

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. 

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.

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.

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.  

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.

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

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.

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) 

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).

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.

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.

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?

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.

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.) 

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.

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,

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.