Tuesday, March 28, 2017

Stress as Gamma

/VX and short VIX have been on a bit of a ride the last few days, and I'm not trying to do a trade journal but I'll just mention some trades only because they got me thinking about gamma and how that relates to life.
Going into the last week or so with the 1st 1% SPY down move in ~110 days, I had all short SVXY puts of varying strikes and expirations. With the down day on the 24th  I added a short Apr 21 142 call to offset an Apr 21 put that was getting close to the money.  With the 2nd down day on the 27th I added a short 133.5 call to offset my weekly, adding a little more downside protection.

Fortunately (or unfortunately, the point being you shouldn't really care and just be prepared either way), that call was sold right at the local bottom and we shot up from there.  I planned to buy stock to cover that call around 133.25 or something, but like an IDIOT I did a limit order instead of stop limit and got the stock at 130.39.  We continued up and I correctly got a stop limit in the next day at 141.50 to cover the approaching 142 call.

I only mentioned this to set up my thoughts on Gamma, which I was contemplating, especially as some of these strikes are weeklies now- and holding straight stock had me watching the full ticks of basically an option at expiration.
I view gamma mainly through the lens of convexity/acceleration around expiration, as your time to be right or to correct from becoming wrong shrinks rapidly, so to me gamma is entwined with time, although that isn't its formal definition in relation to delta.

Like a lot of options topics, I feel gamma intuitively, and I think you should too if you have ever had a project due, a test, presentation, or anything with a time component- Basically STRESS.  (Does anyone not have this experience?)
Is stress just the gamma/acceleration/time convexity of some work/event/underlying?  
 Lets say you are assigned some project/report etc due in a week.

  "OK, we aren't stressed yet, this was just assigned so I'm where I need to be in this progression."

  Now lets fast forward to a day or two away- we haven't started and now have a much shorter time until expiration.  In this case the project is the underlying (like stock) and our delta (underlying directional change) is how "done" the project is. That stress of not being done is the convexity of how much time we have left for needed change to happen. This example is closer to buying a long Out of the Money option, as we start out needing for a directional change (finishing the project).

A short option equivalent (selling an Out of the Money, meaning you need no underlying directional change)  would be like being somewhere and needing not to be recognized,
"I'm almost out of here but what if they are catching on?!"  If something goes wrong there is no time to correct it.  Maybe a better thought is if you have a meeting set up and everything is ready, the fear creeps in about the catering or AV failing, there is no time to correct it right at the start of the meeting! (Having to prep AV a week earlier is no problem, basically a much lower delta effect on the position)

I think the ultimate short option/ gamma stress is death- does anyone else think about options and it immediately goes to thinking about mortality?

 Life is like one big LEAP option, the expiration and strike price are so far out of mind that you don't even worry about it.  Is a midlife crisis then a sudden realizing the convexity of the time we have left and what we have or haven't done?  And what about huge life medical events, is that huge underlying delta acceleration basically repricing where we are at on our LEAP curve just gamma?

Coming back to my initial trade, I ended up getting SVXY stock before I wanted to and sat there watching the full ticks of stock underlying change, where I am usually used to only watching the much smoother change of further away options.  That immediate stress of each tick was unavoidable even though intellectually I knew it meant nothing. 

So what do people do to reduce this stress? PUT IT OFF.  Yet in options land, this is usually the correct approach- rolling to a further duration to reduce gamma, or closing the position at 50% profit.  Maybe this is one case where options and an aspect of life don't add up. 

If these idiots who perpetually roll useless meetings to the next week and next, or put off projects by waiting to hear back on emails only knew what GENIUS option sellers they would be.  (slight sarcasm, but then again who knows)

Is there a takeaway here? Maybe to be more quantitatively mindful of the gamma stress in your own life so it doesn't feel as crazy to you, just realize the natural convexity with time.

Friday, March 24, 2017

Optionshouse Satisfaction Survey

 Today I got a customer satisfaction survey from Optionshouse, which I've left a while ago (Now on Tastyworks)

I've been trying to practice my deep breathing to keep my blood pressure down, but when they just ask for it then its a physical impossibility that I'm not gonna unload.

First there was a little checkbox list of why you are leaving, and it only let me pick one thing- how shortsighted.  Anyway I have no one to share my yelling with, so here is my monologue:

I wanted to select all of the above on reasons to leave, but if I HAD to single out something it would be platform usability.  I'm trying to remember back now to chronicle all the issues sequentially, although this might be out of order-

-At one point they made an overnight margin requirement change that no longer allowed calendar spreads so I woke up with $100k margin call emails,  literal nowhere on the OH site did it mention this and there was NO alert in advance, even though they send monthly advance reminders for whatever little seminar minutia was coming up at the time.  I think I was shuffled around between 3 customer support people trying to get to some kind of manager with some semblance of competence  but alas I was left high and dry.  In terms of customer service insanity, they all said this was a FINRA/SEC requirement for margin and were somehow oblivious that LITERALLY EVERY other broker lets you trade calendars with no problems.  I also couldn't find any evidence of this requirement on any FINRA/SEC web page.

-At one point the accounts summary/positions page just started showing a totally wrong net liquidity, although the individual positions were correct.  This is almost more shocking than the margin issue because I can tally the P/L per position at a glance (LITERALLY ADDITION), so I am completely at a loss about how they broke the basic functionality of adding columns in their software.  For example, excel can have add ins break that use complex functions, but there is no way to break down the absolute building blocks of addition and relation between cells.

-Later, and at multiple points, when sending a limit order, there was no indication that it went through, and no 'pending' order listed anywhere in orders or positions tab.  At this point the software had such a faulty history I assumed some kind of mini crash and put in the same limit order. When that price hit, now both orders suddenly blinked that they filled, doubling my planned exposure.  Fortunately I closed the position later for double the profit because I'm a genius, but no thanks to OH.  A week or two later I entered another trade and just like Charlie Brown with the football, of course the issue wasn't fixed.  I called customer support screaming and in shock that basic order functionality was down for a week or two, and support was super chill like "oh yeah they're working on it. don't worry the order is going through it just doesn't show up"

Frankly I'm semi in shock that OH has the gall to send  out a frowny to smiley face 'how are we doing' survey email, basically confirming that they have absolutely left our solar system in terms of coherence and are in some kind of dimension that we can't even quantify with our current fields of math and physics.

I would be absolutely flabbergasted if this survey was even read by a human.

Is there a metaphor or life lesson here? Unclear.
It was a personal reminder to me to always be looking for improvements; a core part of any business- especially if you view your investing as your own business.  A younger me would still be on OH grinning and bearing it, but if there is a chance to improve your margin or basis, you absolutely have to, that is the difference between 0 and 100.

I can't imagine ever being straight long stock without a covered call component.  If I can get something for .1% less than someone else, that is everything! 

Progress seems very small and incremental, and it is, but that is the water that wears through mountains.

 Thanks for listening


Thursday, March 23, 2017

Tourney vs Cash Poker: the Option Metaphor

 This will be an aside from pure short vix discussion, taking a step back to look at the broader option journey.  If you are trading options/ selling premium now, STOP, and back up and get your poker fundamentals.  If you are coming from the poker world, I'd say you are already a step ahead.  I'll do a broader "poker into trading" post at some point but today I wanted to look at the Tournament vs Cash game poker trajectory in relation to long vs short options.

There are two broad trajectories that poker, options, and many other business models take; the slow grind up with big down spikes, and the occasional huge spike up with a mostly dwindling trajectory otherwise.
Here is a rough picture I've seen, with the left showing a tournament poker trajectory.  The straight vertical line jumps are huge tournament finishes winning 10-20x of the buy in.  The rest of the time is slowly losing buy ins. (with minimum cash payouts here and there, but I'm trying to simplify)
The right shows a cash game trajectory with a slower grind up and occasional big down moves or losing streaks, this is when multiple all-in preflop hands go awry, for example.  (The James Bond hands of straight flush over full house over full house)

What does this have to do with options?  I think these two different trajectories represent the two psychologies of long vs short options.  (And of course as you get more sophisticated you might mix in a lot of long/short option combo strategies, but lets just call this net long vs net short)
The tournament poker chart on the left represents the appeal of long options, paying a small premium (tourney entry) and hoping for a 2 standard deviation move.  You will slowly lose buy ins and get an occasional huge score.  This is the basis of a lot of the entry options content which explain the huge leverage you get and post huge percentage gains while ignoring the losses. 
In contrast, the right cash game chart represents the change to selling options, taking in the premium slowly over time, and having huge outlier moves occasionally hurt you. 

In terms of looking at this like a business, what looks better? I would argue (along with poker players and premium sellers) that the right chart is what you are looking for to better predict returns, smooth out your equity curve, and create overall consistency.  This doesn't mean we will necessarily always over perform or even win, but it is about the psychology of having a strategic system with a smoother curve.  Personally, I don't want to have to be waiting for a big upward spike in my profit curve just to be on track. 

Would you rather have to require or need to avoid outlier moves in order to win over time?

Would you rather need to hit a flush on the river, or have the made hand and need to dodge a flush?

Even the best tournament poker players have all made the bulk of their money from cash games!

One final note on Tourney/cash poker vs options, I would say almost everything in poker translates directly to options, one of the exceptions comes up here in tourney vs cash for bankroll management, or "account size" in options land.  Generally you need a larger bankroll for tournaments because of theoretical outlier moves of not cashing many events in a row.  This contrasts being long options which have defined risk, so the theoretical account requirement is much lower.  Its a good thing to keep in mind how account size/bankroll management fit into all aspects of your life and the different risk profiles of things you do. 

Wednesday, March 22, 2017

Rethinking option correlation and diversification

Here's a portfolio I see in several option videos/discussions when it comes to selling premium:
Strangles/verticals in several underlyings, with the key risk management metric being your max risk in any position is 1-10% of the account. (smaller max risk for large accounts)

For example, in a $100k account, they might have SPY, QQQ, and DIA verticals with $1000 max draw down.  (there are many other positions in metals, bonds, etc, but those aren't the issue)

This sounds OK right? Our max draw down is $1k, and we are within our main risk management bounds.  But then at the same time, they will talk about underlying correlation!
With SPY, QQQ, and DIA having a .7 or higher correlation, (they move almost together), you are just making a giant Frankenstein hybrid SPY beta weighted position.

 Comparing the .7 movement correlation roughly to the drawdown, you are basically adding $700 to your max SPY drawdown from each correlated underlying, turning your risk profile from a 1% max drawdown in SPY to 2.8%. 

I see so many options posts just listing through their positions and adjustments, "here is my SPY strangle, my QQQ vertical, my DIA strangle, hum di dum..."
I just want to smack them out of it, "NO YOU GET TO PICK ONE!"  I'm visualizing it like a kid with 3 candy bars and their parent yelling "YOU ONLY GET ONE!"

Lets take a step back though- Obviously many people are successfully trading short premium with these over correlated positions, so I see a fork in the road:
 1. Realize that you need to shrink position size because you are more correlated than you think
2. Care less about correlation/ diversification!

I'm leaning toward #2, not in the sense that I want equal SPY, QQQ, DIA positions, or have a bunch of metal positions, but just going back to the "PICK ONE" ! 
Additionally, if you are using the conservative 1% of account max drawdown per position, you are going to run into correlation issues to fill up that many positions!

If I was setting up a portfolio with US equities, metals, bonds, etc- Just pick one etf per area, based on volatility/ premium.
Go bigger on just SPY, GDXJ, TLT.  In my case I do advocate short vol as an SPY replacement (combined with a cash position), rather than smaller positions in SPY, QQQ, DIA, SLV, GLD, GDX, etc.
In practical terms for the small investor, we are just saving transaction costs, getting similar exposure for a third of the stock and option commissions. 

(Here are the 3 main indexes moving in lock-step during yesterday's 1% down move)

Furthermore, in a crash scenario, or at least 10%+ correction, correlations get even more heightened.  In short vix land specifically, that >10% correction is the main risk we are dealing with anyway, so a portfolio of short vix would perform similarly to a portfolio of "semi uncorrelated" indices and stocks. (Obviously short vix would spike down much harder, but the overall movement and recovery conceptually would be similar.)
In a large correction, the only real diversification is long vix, which is an overall portfolio drag.  So what real protection do you get from diversification?

Buffet: "Diversification is protection against ignorance. It makes little sense if you know what you are doing"
Cuban (idiot):  portfolio diversification “is for idiots.”

Here's a little real life diversification/correlation comparison to explore when correlations go to 1 and diversification fails:

Lets say I work at an IT desk and a user needs a special account setting changed to access some network files, etc.  Our boss plans there to be plenty of coverage because we have one person dedicated to account permissions, plus a few server admins who can access the function as backup.  We are diversified right? Lets say four people can do this function so someone will be there to help users in a timely manner.  Unfortunately in real life, they all go to lunch at the same time, or are all in the same admin meetings, so their correlation goes to one!  Instead of four people, they are one correlated lunch-eating entity!

  I'm only slightly ranting but it can be for a good purpose to show how really understanding your diversification and correlation risk can permeate every facet of our lives outside of investing.  I can guarantee none of these people in my lunch example have traded EVER because of that kind of correlated insanity would be squashed instantly.

Think about your intrinsic view on correlation, and if you are or actually can by defended from spiking correlation.  If there is no real defense from overnight spiking correlations in a correction, why not just be short vix in the first place? 

Yes I know this all seems massively risky but I think its an important discussion to add least address the shortfalls of the alternative. 

Tuesday, March 21, 2017

Short VIX as SPY replacement

I've always seen short vol as basically correlated with SPY, with the caveat of having a much deeper dip but a similar recovery trajectory.  People seem to dismiss this as just adding more risk and draw down to their SPY/total market position but there is incredible buying the dip power here. 

If you are 100% all in , no dry powder at any time, then yes; XIV/SVXY is going to take a lot longer to recover as vol contracts and S&Ps go back up, but lets consider a 50% cash portfolio at a local top:

Looking at recent years, I examined the August 2015 correction, assuming you have half in SPY, half in cash, or half in cash and half in short vol (XIV, SVXY or cash secured SVXY puts which would actually improve your breakevens when getting assigned on the way down)

Using rough estimates, buying close to the top and then averaging down close to the bottom:
(Obviously in real life there would be more legging in to find a bottom and legging out to lock in profit, "assume a spherical cow", however the difference between the two products would be the same)

~210 to ~186 , about 12% drop
Assuming a 100k account, we would have 50k allocated (238 SPY shares) and average down an additional 268 SPY shares.

Here we can see those two total purchases recovered over the next 2 years to about a 20% profit, completely breaking even by about March.  This is a pretty traditional take on buy the dip, dollar cost averaging, etc, that you might see in a traditional portfolio.
Now lets compare,

~93 to ~48, about 49% drop
Assuming a 100k account, we would have 50k allocated (537 SVXY shares) and average down an additional 1041 SVXY shares.

This is about the same as the SPY recovery trajectory, but oh wait, the Y axis is different. Oh that's right its 4-5x return..

I visualize this as one of those cartoon slingshots.  The correction is pulling down on the slingshot ready for takeoff.  If you are averaging down anyway, then averaging down on something that drops 50% instead of 12% lets you both average down for your breakevens, but can almost double the amount of shares you add, further improving cost basis.  How hard can we pull down on the slingshot?

While XIV/ SVXY weren't around in 2008, some backtests just based on the futures at the time implied at ~95% drop in short vol, compared to a ~50% drop in SPY.  To put that in perspective from the example,
SPY from 210 to 105 would have 238 shares buying 476 more,
SVXY from 93 to 6.50 would have 537 shares buying 7692 more 

As long as the system doesn't fully crack with all short vol funds closing, as long as there is a single thread left- then the "buy the dip" slingshot is still there.

I'm really avoiding doing charts just for chart's sake, but sometimes it is the absolute clearest way to convey something that would take paragraphs.

Monday, March 20, 2017

How do we short Volatility?

I intended this blog for people who are already in the options/VIX space and are sick of it all, and looking for more qualitative rather than quantitative discussion. However, for the new traders or general thespians who are early in the market journey, I thought I'd add a small short vol primer.

The main instruments of short vol:
Buying VIX puts (expensive)
Selling VIX calls
Holding inverse products - buying XIV , SVXY
Shorting long VIX products- short VXX, UVXY, TVIX
Options on these ETFS- Selling UVXY calls, selling SVXY puts

Sixfigureinvesting has incredibly detailed articles on all VIX products

That site really gets under the hood and is something I would recommend reading the whole way through to get familiar with the mechanics of those products.  I didn't simply want to regurgitate other site's overviews here.

In the current historic low volatility, I lean toward selling SVXY puts.  This keeps a guaranteed premium coming in, whereas holding XIV or SVXY could stay choppy to flat. I prefer this to selling VIX calls because any short position like that has the unlimited upside risk, as well as it being cash settled so I can't be assigned SVXY and then start selling calls against it.
 Furthermore, I think SVXY gives a smoother long term slope in comparison with shorting TVIX/UVXY , which have a 2x leverage, as well as associated borrowing costs. Finally shorting any instrument takes on the unlimited upside risk which could be theoretically more dangerous than SVXY going to zero.

When investing in long or short volatility products, I think an incredibly important factor is to keep a large portion of the portfolio in cash, which is a big distinction from the buy and hold, "no dry powder" school.  Cash is a position, I just think many short vol traders overdo it, for example right now at record low VIX I see a lot of short vol traders 100% in cash. 

Part of this blog is trading psychology and even if periods of 100% cash are backtested to be optimal, as a human I don't think I can go there because you really are in the unknown.  Sooner and sooner you will be tearing your hair out watching the market stay flat or up, as it does over time.  At the minimum I would want to keep some amount of short SVXY puts to keep the premium coming in during absolutely flat/ all time high markets, although I would keep over 50% of the portfolio in cash.

The Case for Short Volatility

Before even whispering ‘short volatility,’ we should ask “what is the case to be long volatility?” to have a little context.  Fortunately we don’t have to look far for the long vol advocates, as 90% of articles, blogs, and charts can be summed up as “we are at the all-time high,” “10 charts that guarantee a correction,” “when will the rubber band snap,” etc etc.  Furthermore, all of these articles are written by the ‘contrarians,’ the ones who see the crash before it happens and who get short right at the top and cash in.  More specifically, the ones who haven’t gone broke being short yet.  The question becomes when is the inflection point, when the majority are contrarians, are they still really the contrarians?  How much Healthy Choice ice cream can we eat before it’s no longer a healthy choice?  Of course they are the directional contrarian, but no longer the sentiment contrarian, so which one really matters?

This brings me to what makes the market the purest intellectual challenge, it is two-sided and liquid.  If you think something is stupid, you can take the other side.  Almost nowhere else can we do that; if we think health, car, house insurance is overpriced, we can only take the losing side of that trade. In short vol land, we will definitely be wrong, very wrong, at some point; that is guaranteed.  The concept of future volatility being higher is the entire basis for volatility contago and why short vol trading works.  The entire reason insurance works is because the unforeseen does and will happen. 

However, for the other ~70% or more of the time when volatility is contracting and the short works, we get to be right and profitable.  Combined with the risk management of keeping ~50% or more in cash during low vol, we get to average down into vol spikes, and get the really good short premium scenario in high implied volatility.  If you read anything from any kind of options backtesting sites or blogs, the one consensus is that everything works in high IV.  The short vol strategy gets paid as long as you aren’t in this high profit zone, and then averages down into it once it arrives.
I plan to delve much further and have longer pieces on all of these concepts but this is just to dip into the broad concept of short volatility in all conditions. 

While this started as a joke, it has become ironic, then post ironic, then deadly serious- then a joke that is still serious.  I'll have many posts about the Fed, macro policy and how I see it fitting into short VIX.

Hello World!

There is plenty of content on options trading and general volatility, but I find a lack of pure short volatility discussion (in all environments), as well as volatility discussion in a holistic sense.  How is short volatility a metaphor for life? What deeper discussion can we get instead of posting the same VIX chart?

I’m Robert, I’m in my 20’s in a full time job and I’ve been investing/trading for a couple of years, with a heavy focus on VIX products within the last year.  I was tired of seeing the same 3 posts on bogleheads.com and I really wanted to find a new path and breathe the mountain air.
I hope to start a real discussion on how market volatility and options is at the core of the human condition.  If you’ve felt unsatisfied by reading sites that just post a snipping tool of a trade or a chart, and really want to wax poetic about the deeper journey there, then welcome aboard!

This blog might be for you if any of these scratches one of your itches:

-Options/derivatives/VIX (obviously)

-Hyperbole, meandering metaphors
-Taking things way out of context
-Poker, chess, game theory, pot odds
-“I know the market is 100% rigged, but how do I profit?”