SPY Ratio Diagonal

[cwelsh 1,497]

I didn't.

[luxmon 228]

For those that bought back shorts, what strike/expiration do you plan to sell?  $164 aug 30?

 

Tim

[fieldydwb 31]

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?

Chris, would be interested to hear your thoughts on this as well, I've been playing with this a lot with my strategy posts in the anchor section. I've been striving for delta/vega neutrality while capitalizing on extrinsic/time decay in my testing

[cwelsh 1,497]

I'll be sure to review that and answer for everyone this weekend.  But the poster is right this is NOT delta neutral -- at all.  As long as your puts don't get TOO far OTM though, it doesn't matter.  I'll explain more Sunday -- have client meetings all morning.

 

In other news, it is Friday, and I am rolling the position:

 

SPY @ 166.05

 

BTC Aug 30 167 Put @ 1.56

STO Sep 6  167 Put @  2.08

 

Net credit 0.52

 

Extrinsic value of: 1.13

[cwelsh 1,497]

I rolled this position today:

 

BTC Sep 6 167 Put

STO Sep 13 165 Put

 

Net Debit: 0.91

[fieldydwb 31]

Hi Chris,

 

Any chance you could answer that one question in regards to balancing deltas. Things like going OTM instead of DITM during certain periods and using a positive ratio of OTM (120%) at times rather than DITM.  Love to hear your input.

[cwelsh 1,497]

Ill get to it when I get out of my morning meeting -- I also am going to roll today, but I'm going to let the morning volatility calm down some

[cwelsh 1,497]

In answer to the previous questions:

 

This is NOT a delta neutral strategy, and is never meant to be one -- but it does not have to be in order to be profitable.  Similar to the anchor strategy, as long as we capture the extrinsic values we need, we're good.  We use the ratio to improve our odds in the event the market moves dramatically to the negative (when using puts as we do). 

 

For instance, on the 4:5 ratio that I employee, if we were opening the trade today, the short position would have a delta of .62 and the long would one of .52.  (This is also why I use two weeks out on the short instead of one).  So what happens if SPY drops 5 points?  (assuming a linear application of delta, which isn't 100% accurate, but it's what I'll use for this example), we'd assume a loss of 12.4 on the short (.62 x 5 x 4) and a gain of 13 on the longs (.52 x 5 x 5) -- in other words, almost even.  Now what really happens is the delta spread accelerates faster on the shorts, so I would actually expect a small loss on the shorts.  The option calculator says, the shorts will lose about 13.5 and the longs will gain 13.1.  The FURTHER the market drops though, the closer they get -- which means at some point the longs are always gaining faster than the shorts (since its a 4:5 ratio). 

 

Once the position gets DITM on the longs, I'll switch to a 1:1 ratio for that very reason (so as not to lose on the rebound, if and when it occurs).  Also, once you get closer to a 1:1 delta ratio, DITM, I may switch to only one week out to allow for more flexibility on rebounds.

 

In other words, I don't have to be delta neutral, because I use the ratio.  Now, if there's just a SMALL market drop (as in SPY drops 1-2 points over the week), you can lose ground if you're not getting enough extrinsic value because your shorts lose money, as do your longs because long term volatility might decrease. 

 

But as long as we're getting the extrinsic we want, the position works --_ OVER TIME.  It can be bad in the first weeks, particularly if you get small adverse moves (as occurred here), but as those extrinsic credits build up, the trade profits.

 

I also have started to "cheat" a little.  Let's say I sell the SPY 162 short on a 4:5 ratio.  I don't just "hold" the other 1/5 position out there.  I sell it as well -- just as far OTM as I can only one week out.  For instance this week I shorted, on the 4:5 ratio, two weeks out, the 165 puts.  But I also shorted the "other" 1:5 ratio only one week out, the 159 puts.  This netted me an extra .11 credit.  Those add up over time.

[cwelsh 1,497]

Today is Friday September 6, 2013 and I am rolling the position:

 

SPY is at 166.87

 

BTC Sep 13 Put 165 @

STO Sep 20 Put 168 @

 

Net Credit of 2.21

[cwelsh 1,497]

I ALSO on the other 1/5 did the following:

 

STO Sep 13 161 Put @ 0.12

[fieldydwb 31]

Thanks Chris. Appreciate the insight.

[geneg 1]

Chris, have you backtested the comparative results if you were to always sell the maximum extrinsic value, i.e., closest to ATM?

[cwelsh 1,497]

Chris, have you backtested the comparative results if you were to always sell the maximum extrinsic value, i.e., closest to ATM?

 

Not with this exact strategy, but I did with the Anchor Strategy.  If you go only ATM, then you miss out on gains to intrinsic value in rising markets -- which can come back and bite you quite hard if there is an extended  bull market.

[cwelsh 1,497]

I rolled today:

 

BTC Sep 20 168 Put @ 1.10

STO Sep 27 171 Put @ 3.30

 

net credit of 2.20

[cwelsh 1,497]

Due to the large upswing today, baring a large drop tomorrow, I'll probably roll the position tomorrow.

[cwelsh 1,497]

SPY currently @  173.26

 

4:5 ratio:

 

BTC Sep 27 171 Put @  0.68

STO Oct 4 175 Put @  3.13

 

Net Credit: 2.45

 

AND

 

1:5 ratio

BTC Sep 20 162 Put @  0.02

STO Sep 27 Put @  0.15

 

Net Credit: 0.13

[brownrc 2]

SPY currently @  173.26

 

4:5 ratio:

 

BTC Sep 27 171 Put @  0.68

STO Oct 4 175 Put @  3.13

 

Net Credit: 2.45

 

AND

 

1:5 ratio

BTC Sep 20 162 Put @  0.02

STO Sep 27 Put @  0.15

 

Net Credit: 0.13

Hi Chris,    Strike price on the   "STO Sep 27 Put @  0.15" ?        Thanks.

[luxmon 228]

Chris,

 

I noticed with today's roll the margin requirement is getting quite high (I'm doing this in an IRA so it's a bit of a sting on free cash).  Are you considering rolling the long up and out soon? 

 

FYI, I'm happy that the trade is profitable along with the downside protection we've had all along - very well done so far.

 

Thanks,

Tim

[cwelsh 1,497]

It is getting very close to the point where we'd roll up and out.  I try to wait until a 10% move (so around 178), but I might do it as soon as 175.

 

You are correct though.

[fradav 1]

Hi Chris, regarding rolling a week earlier than expiry, with the delta's of ITM puts from 173-180 almost identical between puts that expire tomorrow and in a week or 2 (from about .5 to .8 respectively), wouldn't it make more sense to leave until expiry or close to expiry to maximise extrinsic unless they're very DITM? Or is it protection against a crash? Or does it allow us to get further ITM whilst getting the needed instrinsic to protect longs in a strong move up? 

 

Thanks!

[Marau 4]

If my records are correct I only need about $200,00 more to get payed for the entire long (my ratio is 1:1). Do you think I should roll anyway?

[cwelsh 1,497]

If my records are correct I only need about $200,00 more to get payed for the entire long (my ratio is 1:1). Do you think I should roll anyway?

 

In the Anchor Fund, the answer would be absolutely, because we are actually protecting long stock/etf holdings as well.  In this though, it's a little more flexible and depends on your time horizon.

 

As was noted, the further the spread between the long position and short, the greater the margin requirements, which does lower your ROI.  However, we're way ahead of pace on paying for the trade and earning income, so rolling would be "cheaper" relatively speaking than when we opened the trade the first time -- but it would also extend the time period for the trade.

 

So there's a trade off.  As I plan on continuing to roll this trade for quite a while, if SPY hits the 175-178 range, I'll probably roll, but, depending on your specific needs based on margin, time horizon, and ROI, your answer could be different.

[cwelsh 1,497]

Well there is a huge difference between .5 and .8.

 

The problem with waiting until expiration is that it makes you more vulnerable to price falls.  We keep rolling one week out, at least until our shorts are significantly below the longs, because when the price drops there is still some value left that's not there right before expiration. 

 

Hi Chris, regarding rolling a week earlier than expiry, with the delta's of ITM puts from 173-180 almost identical between puts that expire tomorrow and in a week or 2 (from about .5 to .8 respectively), wouldn't it make more sense to leave until expiry or close to expiry to maximise extrinsic unless they're very DITM? Or is it protection against a crash? Or does it allow us to get further ITM whilst getting the needed instrinsic to protect longs in a strong move up? 

 

Thanks!

[fradav 1]

Chris, I meant that the delta values for the 1 week versus 2 week expiry almost mirrored one another within a range, not that there was only a .5 to .8 difference for corresponding options with different expiry dates. But ok, if it gives you better downside protection I understand (although I would have thought this would even out when SPY goes up again since closer to expiry with higher delta lose value quicker.

 

But the system clearly works, one week or 2

Edited September 23, 2013 by fradav

[cwelsh 1,497]

It works over time, as we can see by this week, you can certainly have extremely bad weeks.  I just like the two because it reduces the "pain" of the bad weeks -- but you are correct, in swift moving markets you do fall behind faster (that's the trade off -- Id rather lose downside risk and lose upside potential and coast down the middle -- that's the whole point of the strategy)

 

 

Chris, I meant that the delta values for the 1 week versus 2 week expiry almost mirrored one another within a range, not that there was only a .5 to .8 difference for corresponding options with different expiry dates. But ok, if it gives you better downside protection I understand (although I would have thought this would even out when SPY goes up again since closer to expiry with higher delta lose value quicker.

 

But the system clearly works, one week or 2

[cwelsh 1,497]

I did roll today, Friday, September 27:

 

4:5 ratio

 

BTC Oct 4 175 Put @

STO Oct 11 170 Put @

 

Net debit of 3.90

 

1:5 ratio:

 

BTC Sept 27 167 Put

STO Oct 4 165 Put

 

Net credit of .31

[cwelsh 1,497]

Today is Friday October 4, 2013, and I'm rolling the weekly position:

 

SPY@ 168.55

 

On the 4:5 ratio

 

BTC Oct 11 170 Put @   2.04

STO Oct 18 170 Put @  2.60

 

Net Credit: 0.56

 

On the 1:5 ratio

 

Btc Oct 4 165 Put @0.01

STO Oct 11 165 Put @0.35

 

Net Credit 0.34

[QZW 6]

edit

Edited October 5, 2013 by QZW

[cwelsh 1,497]

SPY is currently at 167.92

 

I'm rolling the 1:5 ratio part of the trade only today (will do the rest tomorrow)

 

BTC Oct 11 165 Put @ 0.10

STO Oct 18 163 Put @ 0.43

 

Net Credit: 0.33

[QZW 6]

SPY is currently at 167.92

 

I'm rolling the 1:5 ratio part of the trade only today (will do the rest tomorrow)

 

BTC Oct 5 165 Put @ 0.10

STO Oct 11 163 Put @ 0.43

 

Net Credit: 0.33

Chris, are the dates correct? 

[cwelsh 1,497]

fixed

[cwelsh 1,497]

Today is Friday October 11, 2013, and I'm rolling the 4:5 ratio:

 

SPY@ 169.25

 

BTC Oct 18 170 Put @   1.75

STO Oct 25  Put @  2.24

 

Net Credit: 0.49

[fieldydwb 31]

A little over-run here as well. Rolling short today?

[cwelsh 1,497]

Today is Monday October 21 and due to the large late week run up I'm doing a VERTICAL roll on the 4:5 ratio:

 

BTC Nov 1 173.5 Put @ 

STO Nov 1 174.5 Put

 

Net credit of: 0.40

[fieldydwb 31]

Hi Chris,

What is your long put currently? 162 still? When do you like to do your long rolls in the diagonals?

[cwelsh 1,497]

Hi Chris,

What is your long put currently? 162 still? When do you like to do your long rolls in the diagonals?

 

yes, and if the market is anywhere near 175 on Friday I'll be rolling this week.

[cwelsh 1,497]

Actually I might even do it today after lunch -- this trade since inception is up 15.5% for me (since end of June).  If I rolled to the Feb 175, the break even number would be around .35/week, which is even better than we started with.  Under those conditions, this is an ideal time to roll.  I'll post when/if I do.

[fieldydwb 31]

You are more liberal with diagonals as opposed to anchor. I have 164 and 165s. Would you roll those?

[cwelsh 1,497]

Today is October 23, 2013 and I rolled the long puts

 

SPY is currently at 174.30

 

STC Jan 2014 162 Put @  1.47

BTO Feb 2014 175 Put @  6.10

 

Net debit of $4.63

[cwelsh 1,497]

You are more liberal with diagonals as opposed to anchor. I have 164 and 165s. Would you roll those?

 

I am much more liberal with the diagonals in this forum because its a very different style of trade.  This trade is meant to be income producing and bears much more risk than the anchor trade.  The purpose of the trade is different.  The ONLY purpose of the diagonal spread in the anchor side of things is to hedge the long stock/etf holdings and grow over time with minimal risk.

 

This trade carries a higher degree of risk and is meant to be income producing. 

 

So while I am nearing a roll point for the anchor strategy, its not quite there yet.

[fradav 1]

Good one Chris.  Is that 15.5% profit based on cost of original longs? 

[fieldydwb 31]

Yep, no I know. Just wondering what metric you like to use for rolling diagonals since we are more liberal with them. I am looking to roll my 164/165s at around 177

[cwelsh 1,497]

Good one Chris.  Is that 15.5% profit based on cost of original longs? 

 

It's the total of everything I've done -- I just download from TDAmeritrade the spreadsheet of all SPY trades since 6/20.

 

If you're asking what the denominator was, it was total amount invested on the longs.  I actually doubled up the position a few weeks in.  For example, I had 20 long contracts to start and 3 weeks later had 40 -- so I counted the "cost" as the total 40.

[cwelsh 1,497]

Yep, no I know. Just wondering what metric you like to use for rolling diagonals since we are more liberal with them. I am looking to roll my 164/165s at around 177

 

I roll when (a) I can do so and lower the cost (as in here) ( when I feel the market is nearing a top and © when my margin is getting out of control and I'm losing available cash on other trades.

[QZW 6]

I am also in the diagonal game for the last month or so, thanks. For experiments, bought 10 puts for September 2014 (168 strike price) and roll 8 slightly ITM bi weekly puts, just like in Anchor. Will wait to roll the longs, for SPY to be around 180 or so to roll. So far, it has been producing some income. Any advice if I do it right?

As far as 1:5 ratio diagonal, I could not find a well-tested or a well-defined strategy. Instead, I sell 50 to a 100 of OTM weekly puts on SPY pullbacks or $1 or more, for income. Is this a legit strategy? So far, I have not had to roll these puts, just let them expire worthless. Is this a waste? Hope there will be posts on condors for income...

QZW

Edited October 24, 2013 by QZW

[Marau 4]

 

 

This trade carries a higher degree of risk and is meant to be income producing. 

 

 

Regarding the GLD the trade has been more like, say, an "outgo" producer lol.

 

But this one has been a good trade. Thks. Chris.

[cwelsh 1,497]

The GLD trade is certainly under performing, particularly when compared to this one, but there's still time left in it.

[QZW 6]

The GLD trade is certainly under performing, particularly when compared to this one, but there's still time left in it.

Chris,

GLD is all over the place and I cannot figure where it is heading; I do not trade it. On the other hand, do you think diagonals on IWM and QQQ are legit? Volumes are not great, but acceptable. Could be another good weekly trade like SPY.

Thanks.

QZW

[cwelsh 1,497]

As usual, I am rolling today.

 

On the 4:5 ratio:

 

SPY is at: 175.40

 

BTC Nov 1 174.5 Put @ 0.71

STO Nov 8 176 Put @ 1.78

 

Net credit of: 1.07

 

On the 1:5 Ratio:

 

BTC Oct 25 172 Put @ 0.01

STO Nov 1 172 Put @ 0.25

 

Net Credit of: 0.24

[cwelsh 1,497]

Chris,

GLD is all over the place and I cannot figure where it is heading; I do not trade it. On the other hand, do you think diagonals on IWM and QQQ are legit? Volumes are not great, but acceptable. Could be another good weekly trade like SPY.

Thanks.

QZW

 

GLD is all over the place, I agree.

 

And yes, you could do this just as well on IWM or QQQ, however both of those are fairly highly correlated to SPY.  If you traded those, you would essentially just be taking on more risk on the same trade.  The reason I did GLD and SPY is because they don't always move in tandem.