SteadyOptions is an options trading forum where you can find solutions from top options traders. Join Us!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

cwelsh

SPY Ratio Diagonal

211 posts in this topic

Recommended Posts

With the 1% market up move today, I went ahead and did tomorrow's roll today:

 

SPY @ 166.74

 

Buy to close the July 20 165 Put @ 0.69

Sell to open the Jul 26 167 Put @ 1.83

 

Received a net credit of: $1.14

 

Extrinsic value on the July 26 position of: $1.57

 

Goal per week lowered to: $0.76

 

This trade is now ahead of pace to average 5% gain by the time the long puts expire in December. 

Share this post


Link to post
Share on other sites

In answer to one of the previous comments -- I do NOT like one week, or one month (e.g. a short cycle) ratio or diagonal trade, for the very reason demonstrated with SPY this week (as well as GLD).

 

Our paper position is showing a loss because, particularly if you were in a ratio, the value of your long position decayed more than your short position gained.  If we were closing the entire positions today, it would be for a loss.

 

However, we captured MORE extrinsic value than was our goal.  By making this a "long term" trade, even though we have a paper loss, our trade on our time horizon is actually better off today than it was last week. 

 

I normally don't put the number of contracts I buy, but I think understanding the exact math here is important:

 

When I opened the trade I:

 

Buy to open  50 SPY Dec 2013 157 Put @ 8.53

Sell to open  40  SPY June4 160 Put @ 2.69 (0.54 extrinsic at the time)

 

When the trade was opened, there was 20 weeks left on the trade, including that week.

 

So my cost was: 50 * 100 * 8.53 = $42,650.00

LESS 40 * 2.69 * 100 = $10,760

Total: $31,890.00

My profit target was 5% per week = 5% * 20 * 31890 = $31890

 

So my total to "pay off" is = $31890 + $31890 = $63,780

 

How much is that per week? = $63,780 / 20 weeks / 40 contracts per week / 100 = $0.80

 

And how are we doing now?  Well two weeks in, after today's roll, I have "lowered" that needed per week from $0.80 to $0.76 (that's inclusive of commissions as its from my actual trading account).  So while the trade is down, and we'd lose if we close today, we're "ahead of pace" -- which is a good thing.

 

If you have questions, just let me know.

Share this post


Link to post
Share on other sites

Tim:

 

As the long puts become more and more in the money, the delta on the position gets closer and closer to 1.  That means when the market drops further, then the long puts will gain value at a rate very close to the short puts.

 

Right now, if the market drops, the short puts will lose money faster than the longs, so we are in a ratio of about 80% short/long.  Once we are more in the money on the long puts, we remove that ratio because if the market keeps going down, the risk of losing more is going away, whereas if there is a rebound we want to capture more intrinsic value.

 

Remember this is a negatively biased trade, if the market keeps going up, let's say to 175 or so, over the next month, we'll have to roll the long puts "up and out"

Chris, Why wouldn't the vega difference--with the long having much higher vega than the short--more than counterbalance the smaller delta difference if the market drops  and VIX goes up?

Share this post


Link to post
Share on other sites

Why not use the delta relationship as a guideline to decide how many shorts to sell? So if the longs are significantly ITM you would need to sell more deltas to come close to delta neutral, and vice-versa if the longs are OTM?

Share this post


Link to post
Share on other sites

We don't want to be delta neutral, if so I'd have an inverse ratio.  If I have a widely variable number of puts I sell each week (lets say from .5X to 1.5X), it makes having a "goal" of extrinsic value each week much more difficult.

 

As to your question on vega -- if the market drops, vega goes down as the options become more and more in the money, so it becomes less and less relevant.  Once your delta gets close to 1, vega will be close to 0.

Share this post


Link to post
Share on other sites

We don't want to be delta neutral, if so I'd have an inverse ratio.  If I have a widely variable number of puts I sell each week (lets say from .5X to 1.5X), it makes having a "goal" of extrinsic value each week much more difficult.

 

As to your question on vega -- if the market drops, vega goes down as the options become more and more in the money, so it becomes less and less relevant.  Once your delta gets close to 1, vega will be close to 0.

Then I'm still a bit confused about this strategy. It would seem that if it's primarily an income strategy--which I thought it was--and we are not continually trying to guess the direction of the market, we would want to be as close as reasonable to Delta and Vega neutral, and rely on Theta decay for income. Perhaps I'm mistaken, but please clarify this for me.
As for what happens when the market drops, it seems to me that it would have to drop an awful lot to get the longs to Delta 1 and Vega 0--as long as they are a few months out. And--as I read the option chains--the near term sold options would get to delta 1 pretty fast. 
For example, when I look at the TOS SPY chains today, if we were to extrapolate that we had bought December options at 205--projecting about a 40 point drop in SPY--today those would have a Delta of -.95 and Vega of .10. However, if we also project a 10 point rise in VIX (perhaps conservative for this size market drop!), the Delta gets smaller to  -.84 and the Vega increases to .26--hardly negligible. Also, as I read it, the a short would get to Delta 1 with a drop of only about 7 points, then lose money via Delta effect faster than a long would gain(unless we are Way down in another 2008 crash), perhaps partially offset by the effect of the higher Vega of the long as IV rises. Please correct if you seen an error in my calculation or understanding.
But bottom line, I'm not suggesting  a hard and fast quick maneuvering all over the place when Delta changes a little bit, but rather keeping an eye on the movement of the combined trades' Delta and Vega as valuable input on deciding when to add or subtract shorts. Isn't this similar to your guideline to reduce shorts when the longs are OTM and increase shorts when the longs have gone significantly ITM?
 It would seem that the important question--focusing on one side of ATM--of "how far ITM do you start adding shorts" is similar to the question of "at what Deltas or Delta difference  do you start adding more shorts." Obviously if you've gotten near Delta 1 in the longs you would sell max shorts--or a ratio of 1 to 1. But for your guideline what criterion would you suggest using before you get there? Is it mostly a discretionary call based on projected changes in market direction?

Share this post


Link to post
Share on other sites

I'm still going round and round about how this trade works, so I did a checkpoint today.  I'm doing a 20 long / 16 short ratio mostly following Chris' moves (except I rolled the longs up once early from 158 to 162, probably stupid move).  Here's currently where the trade is at:

 

Original long cost (including roll up from 158 to 162):  -$19,600

Current value of long puts:  $9580

Total income from selling 16 weekly shorts per Chris' moves:  $7,717

Current unrealized loss:  -$2,303

 

I am meeting the 5% per week goal though on selling the shorts, so I'm trying to ignore this paper loss.  I'm worried about the weeks likely to come when the shorts lose big.  The theory is the longs will gain more than the shorts lose due to the ratio and higher vega on the longs, correct?

Share this post


Link to post
Share on other sites

I'm still going round and round about how this trade works, so I did a checkpoint today.  I'm doing a 20 long / 16 short ratio mostly following Chris' moves (except I rolled the longs up once early from 158 to 162, probably stupid move).  Here's currently where the trade is at:

 

Original long cost (including roll up from 158 to 162):  -$19,600

Current value of long puts:  $9580

Total income from selling 16 weekly shorts per Chris' moves:  $7,717

Current unrealized loss:  -$2,303

 

I am meeting the 5% per week goal though on selling the shorts, so I'm trying to ignore this paper loss.  I'm worried about the weeks likely to come when the shorts lose big.  The theory is the longs will gain more than the shorts lose due to the ratio and higher vega on the longs, correct?

Our goal is that the losses on the shorts EQUAL or are less than the gains on the longs.  However the more OTM the long puts become (eg we are selling puts significantly above where our long puts are), the less likely this becomes.

 

We have two possibilities then:  (1) as long as we're ahead of our 5% per week target, don't worry about a 1-2 week loss on the shorts (2) reduce the ratio further (which makes hitting the per week goal harder) or (3) roll the long puts up and out.

 

Right now I'm in box (1).  I'm ahead of my 5% per week target, and the market has moved from 162 - 167 (a 3.1% gain).  Once the market moves another five points up (to the 172 range), I'll start watching to roll up and out.  I CERTAINLY will roll up and out after a 10% gain (in the 178 range). 

Share this post


Link to post
Share on other sites

I'm still going round and round about how this trade works, so I did a checkpoint today.  I'm doing a 20 long / 16 short ratio mostly following Chris' moves (except I rolled the longs up once early from 158 to 162, probably stupid move).  Here's currently where the trade is at:

 

Original long cost (including roll up from 158 to 162):  -$19,600

Current value of long puts:  $9580

Total income from selling 16 weekly shorts per Chris' moves:  $7,717

Current unrealized loss:  -$2,303

 

I am meeting the 5% per week goal though on selling the shorts, so I'm trying to ignore this paper loss.  I'm worried about the weeks likely to come when the shorts lose big.  The theory is the longs will gain more than the shorts lose due to the ratio and higher vega on the longs, correct?

 

As extra encouragement, there are still 22 more weeks until the December long puts expire.  In three weeks of rolling, you've averaged just over $2,500.00 per week. If that continues for the next 22 weeks (it won't), you'll net another $55,000.00 for a total of $62,500, on a $19,600 original investment.  That's beyond a home run (and why I say I'm not worried about this trade right now).  As long as you average $540 per week for the next 22 weeks, you'll break even. 

Share this post


Link to post
Share on other sites

Am planning on entering this trade now with a slight variation in the set-up, will sell ATM weekly puts against Dec168's with a ratio of 3:2 long to short. My thinking is that I'm entering with SPY at around 168 (as compared to 158 when Chris placed his original trade) and I want to optimise profits on neutral weeks whilst giving up some gains on bullish weeks (as opposed to the short ITM puts with enough extrinsic to cover cost long term) and having a slightly better delta hedge for down moves as compared to a 5:4 ratio.

 

Of course you can never guess the market direction but my best guess is more sideways for a while rather than breaking way through all time highs.

 

Does this sound reasonable? 

 

Thanks for any feedback.

Edited by fradav

Share this post


Link to post
Share on other sites

I tend to agree with you -- I just don't see S&P 500 at 1750+ in the near future.  It could happen (heaven knows how often I've been wrong on market direction).

 

The ratio absolutely optimizes profits on slightly down weeks, while giving up some on up weeks -- so you're right on that.  And if SPY slips down into the 160 range (from 168), you can always discard the ratio.

Share this post


Link to post
Share on other sites

Thanks a lot Chris. One question:- I know with ICs and calendars it's best to avoid holding shorts close to expiry. In this trade I'm using 50% more longs to offset short:long delta ratio which is approx .5 (long) to .8 (short) in week prior to expiry for ITM options. However that still wouldn't cover the final day or 2 when gamma takes over. Do you recommend rolling weeklies early to avoid the danger? I notice from your earlier trades you're sometimes rolling 7-10 days in advance once the shorts are ITM.

Edited by fradav

Share this post


Link to post
Share on other sites
Guest Hal

For argument's sake, let's say you're bullish as a matador and DO see SPY breaking all-time highs by year's end. Assuming you currently have no position, would you:

  1. put on the same trade
  2. put on the same trade, but pick a higher strike for the long?
  3. do this trade with calls instead of puts?
  4. avoid this type of structure altogether?

Or you can pick what's behind door #3.  :) 

 

Thanks. 

Share this post


Link to post
Share on other sites

Hal, am not expert but 1 and 2 are out, longs puts get crushed. As Chris mentioned earlier this trade is best in neutral/downward market (or slowly rising). Doing it with calls would work (but for me too risky as I believe it's easier for market to fall down than up)

 

So if I was very bullish I'd just sell an ATM put credit spread with small allocation or the above trade (option 3) with calls.  Of course I could buy naked calls if I was uber bullish but been burnt too often doing that.

Edited by fradav

Share this post


Link to post
Share on other sites

Thanks a lot Chris. One question:- I know with ICs and calendars it's best to avoid holding shorts close to expiry. In this trade I'm using 50% more longs to offset short:long delta ratio which is approx .5 (long) to .8 (short) in week prior to expiry for ITM options. However that still wouldn't cover the final day or 2 when gamma takes over. Do you recommend rolling weeklies early to avoid the danger? I notice from your earlier trades you're sometimes rolling 7-10 days in advance once the shorts are ITM.

 

Until I'm DITM on the longs (which we're no where NEAR right now), I will typically roll at least 7-8 days before -- I do that to again reduce the risk of loss on the shorts in a declining market. 

 

The counter argument to that is, by selling a week early, I actually am sacrificing some extrinsic value/time decay since that decays faster, the closer to expiration.  But here's how I look at it -- if the market goes down, I lose less on the shorts because of delta and time value, while still earning that extrinsic value.  On the other hand, if the market goes up, then, while I don't capture as much extrinsic value, I earn EXTRA intrinsic value, which more than offsets it -- it's worked like a charm so far.

Share this post


Link to post
Share on other sites

Hal, am not expert but 1 and 2 are out, longs puts get crushed. As Chris mentioned earlier this trade is best in neutral/downward market (or slowly rising). Doing it with calls would work (but for me too risky as I believe it's easier for market to fall down than up)

 

So if I was very bullish I'd just sell an ATM put credit spread with small allocation or the above trade (option 3) with calls.  Of course I could buy naked calls if I was uber bullish but been burnt too often doing that.

 

Yes, the longs are getting crushed, however, we are still AHEAD of our goals per week -- which is a great thing.  If SPY hits 170, I'll probably roll up and out, but right now, I'm not worried about this trade.  Yes, I don't like the effect it has had on my daily balance, but just work it out, so far we're doing great.

 

There's 29 weeks left on my trade, My target is right around .70 a week, and I've been averaging $1.40 per week. 

 

If the market goes up to 170 tomorrow, and I roll up and out, I'll actually STILL be ahead of my opening position.  You should never ignore your paper losses, as if you have to exit for some reason, they all of a sudden become very real.  But right now, the original premise of the this trade still holds.

Share this post


Link to post
Share on other sites

For argument's sake, let's say you're bullish as a matador and DO see SPY breaking all-time highs by year's end. Assuming you currently have no position, would you:

  1. put on the same trade
  2. put on the same trade, but pick a higher strike for the long?
  3. do this trade with calls instead of puts?
  4. avoid this type of structure altogether?

Or you can pick what's behind door #3.  :)

 

Thanks. 

 

DO NOT put on the same trade, that makes no sense.

 

I would still do this trade, just with SPY at the current levels (so 168 instead).  Just be aware that if the markets keep going up, you will experience temporary paper losses until your weekly short credits catch up to your long costs.

 

Now if you say you're as "bullish as a matador" -- in other words you see the S&P 500 increasing another 15-20% by years end, I would avoid this trade all together.  I wouldn't even trade the inverse of it.

Share this post


Link to post
Share on other sites

As of right now, I don't think I"m going to roll today, but if the market keeps going up I may.  (SPY currently at 168.80).  There is still more than .80 left in extrinsic value, and I would like to see that down around .70 or less before rolling OR the theta values within .01 this week to next week.

Share this post


Link to post
Share on other sites
Guest Hal

Chris, thanks. I don't know about another 15-20%, but I do feel the SPY will be up by year's end, which is one of the reasons I didn't get in on this trade. I do think gold is going down, and so far am quite happy with how the GLD diagonal has been behaving. But I was just wondering if and how one might put together a similar income-earning structure when bullish on an equity. From what you're saying, it sounds like these structures are really only appropriate when you have a neutral-to-bearish outlook.

 

Thx fradav, for your input; much appreciated. I'm comfortable with put spreads; it's this kind of diagonal calendar, income-earning structure that's totally new to me.

Share this post


Link to post
Share on other sites

Well you can do the inverse of the trade using calls -- but those typically do not perform quite as well because (a) calls are traditionally cheaper than puts (so less value), and (B) huge dramatic swings in either direction make these trades harder to manage.  I don't mind them at all in constant, mildly trending markets either way.

Share this post


Link to post
Share on other sites

And I know I said I wasn't going to roll, but that price is now down to .70, so I am rolling:

 

SPY @ 169.05

 

BTC July 26 168 Put @ 0.72

STO Aug 2 169 Put @ 1.61

 

Net credit of $0.89

Extrinsic value of $1.61

 

I netted $1.49 on last weeks put (including the in-week roll)

 

I need $0.80 in extrinsic value over the next 26 weeks to meet my profit target, (I'm back on the 5:4 ratio, if you stay at 5:5 you only need 0.64, but are at a higher risk in the event of a market pull back)

Share this post


Link to post
Share on other sites

For anyone wanting an update, here's how my positions are holding up:

 

Accounting for all rolls, my long puts (current at the Jan 2014 162 strike) are down 48.24% (seemingly an ouch)

 

Yet, so far, I've been averaging 1.63/week, which is almost double what I need. 

 

In other words, I'm very happy on how things are going.

Share this post


Link to post
Share on other sites

 

 

Yet, so far, I've been averaging 1.63/week, which is almost double what I need. 

 

 

Chris, Am I correct to understand the above statement is $1.63 extrinsic at SALE, not actually captured. Or did you actually captured that much? I was in the ratio 4 to 5 for duration thus far, and only captured $0.96 on average per week per option. 

Share this post


Link to post
Share on other sites

Chris/Max, what will happen when we get close to expiration on the long put. do we unwind early to avoid the theta decay on it? or do we unwind it at the same time as the last batch of weeklies we sell? 

Share this post


Link to post
Share on other sites

Chris/Max, what will happen when we get close to expiration on the long put. do we unwind early to avoid the theta decay on it? or do we unwind it at the same time as the last batch of weeklies we sell? 

 

It depends. I think most likely for me[for this specific trade], if the rise continues, I will simply roll up and out and keep the trade going. But in general, I would either close or roll up/out at no later than 2 month before the expiration of the long. Exactly for the reason you are pointing out. Don't want theta decay to eat away at the long too much. 

Share this post


Link to post
Share on other sites

It depends. I think most likely for me[for this specific trade], if the rise continues, I will simply roll up and out and keep the trade going. But in general, I would either close or roll up/out at no later than 2 month before the expiration of the long. Exactly for the reason you are pointing out. Don't want theta decay to eat away at the long too much. 

 

but then how are we ever going to realize the x% profit target per week? technically the trade will never end? 

Share this post


Link to post
Share on other sites

but then how are we ever going to realize the x% profit target per week? technically the trade will never end? 

 

That's why we have to wait and determine how its performing.  With four weeks left, we should be well into the profit zone.  We may even be ahead of pace, in which case I would roll because it's cheaper. 

 

There's just a ton of variables here:

 

1.  Are the puts ITM, ATM, or OTM?  DITM puts, I'm much less likely to roll, because theta is not going to make up a large portion of those anyways;

2.  Far OTM puts are more likely to be rolled sooner because all they have left is theta;

3.  ATM, we'll have to look at the pricing.

 

And then where are we on paying/earning ?

 

1.  Am I way ahead of pace?  If so, then I'll probably roll sooner, because I can do the same trade for "cheaper";

2.  Is it going to be IMPOSSIBLE to meet the goal?  If so, I'll probably roll sooner to preserve as much theta as I can to make my goals more attainable

3.  Or am I right on pace and have a better trade idea, in which case I might not roll at all, and just keep on keeping on.

 

This is a great type of trade to think through the various outcomes and what to do in the case of each.

Share this post


Link to post
Share on other sites

Chris,

 

Any way we can get an update on all the transactions so far, for those of us still trying to grasp the concept of the trade? It would help to visually see each cost/position and adjustment line item, etc to see what has happened and how you will continue to build on the trade. If that's too much trouble, no worries.

Share this post


Link to post
Share on other sites

Here you go --  I normally don't include my trade sizes, but this well let you see exactly what I've been doing:

 

post-76-0-21877300-1374764008_thumb.png

 

Some of the comments got snipped, but if you have questions on a particularly week, just let me know.

 

As you can see, part of the reason I think this trade is still working well -- we initially needed .87 a week to meet our profit target -- we're currently down to needing only .80/week.  As of right now this week isn't going as well (only have netted about .15 so far on the week), but theta decay will give us another .07 or more by tomorrow, and if the market stays flat or goes up slightly, we'll get even more. 

 

The "total gain loss" and "credit receive so far" are both a little off as they each assume we keep the entirety of the credit from this week (so above the full 6,440), and that just probably won't happen. 

 

I keep the "off ratio" number in case the longs get to be DITM, then I know what my target has to be.

Share this post


Link to post
Share on other sites

chris/max, if the market stays flat, come friday should we just let the short expire or still buy it back? 

 

for instance, instead of closing the short and selling at the same time on friday, would it be a bit better to let the short expire and sell to open on monday? 

or does this not really matter.

Share this post


Link to post
Share on other sites

chris/max, if the market stays flat, come friday should we just let the short expire or still buy it back? 

 

for instance, instead of closing the short and selling at the same time on friday, would it be a bit better to let the short expire and sell to open on monday? 

or does this not really matter.

 

 

I do not think anything is expiring... remember we are using 2 weeks out.. So the shorts still have a week in them. 

Share this post


Link to post
Share on other sites

The shorts do have a week left in them, but we are two weeks out for this exact reason -- the shorts are down, but should be down about an equal amount to the longs being up --- BECAUSE there's a week left in them.  I most likely will roll today, not guaranteed, but probably. 

 

Right now I have the following order in, but it's not been filled:

 

SPY @ 167.78

 

BTC Aug 2 169 Put

STO Aug 9 168 Put

Net CREDIT of .10

 

Obviously I'm no where near being filled, as the midpoint is a net DEBIT of .12, but I have the order entered in case the market shifts while I'm waiting.  I'll make the final decision later this afternoon.

Share this post


Link to post
Share on other sites

oh i meant on expiration week. technically we would collect a bit more if we let it expire if the shorts are OTM right? 

 

Yes, but you would more exposed to gamma. (change in underlying impacts option more close to expiration). So if there is a big sudden move a day before expiration, you will get a delta close to .9 or something. The 2 week approach has lower delta.... so any big move is less impact full. As Chris mentioned before, and I agree, until your long is deep in the money the 2 week approach seems less risky. 

 

Also, the 2 week approach reduces assignment risk, as its much less likely for someone to exercise the option with a week worth of time value. 

Share this post


Link to post
Share on other sites

Ok, the price has come back and I am now trying to get the following fill:

 

SPY @ 168.71

 

BTC Aug 2 169 Put

STO Aug 9 169 Put

 

Net Credit 0.40

 

As long as SPY stays around where it is today I WILL ADJUST THE PRICE, down to 0.35 as closing approaches if necessary.  That would lock in about .70 from the previous week, which is close to my target rate.  I'm willing to sacrifice .10 to avoid getting waxed if the market moves down on Monday or Tuesday.  Again, I will be adjusting to get a fill, but with an hour left of trading might not have time to update things.

 

Of course if the market moves up on Monday or Tuesday, this will have been the wrong call, but since I don't KNOW what will happen, I feel this is the safer approach.

Share this post


Link to post
Share on other sites

I went ahead and rolled today:

 

SPY @  170.62

 

BTC Aug 9 169 Put @   0.60

STO Aug 16 171 Put @  1.73

 

Net credit:  1.13

Extrinsic value for next week: 1.35

 

From last week:  Needed .82, received 0.95

For this week:  Need 0,81  max of  1.73

Share this post


Link to post
Share on other sites

Just wanted to update my trades. (i set a lower target of 3% a week for 25 weeks)

 

BTO 50 SPY Jan 18 169 Puts for -7.43  

STO 40 SPY Aug 2 169 Puts for +1.26

BTC 40 SPY Aug 2 169 Puts for - 0.35 (extrinsic received = 0.91 vs needed 0.65) *needed 0.65 if stay on 4:5 ratio.

STO 40 SPY Aug 2 170.5 Put for +0.86 (this was yesterday)

BTC 40 SPY Aug 2 170.5 Put for -0.35 (received an additional 0.51, so net this week received total of 1.42 vs needed of 0.65)

STO 40 SPY Aug 16 171 Put for +1.60 

Edited by Mikael

Share this post


Link to post
Share on other sites

Just rolled for today:

 

BTC Aug 23 170 Put @ 3.63

STO Aug 30 167 @ 1.90

 

Net debit of 1.73

 

Yes, bad week on the shorts, but we actually gained more on the longs, so so far so good.  Just be ready to roll up Monday if we get a bounce.

Share this post


Link to post
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

  • Recently Browsing   0 members

    No registered users viewing this page.