Trades while waiting for VIX and a poker metaphor-

A little update while waiting for a vol pop as I closed out of the long duration UVXY shorts from this last year...
First a little context and my clickbait "THE ONE CHART THAT SCARES ME"

 This is 1yr rolling % change for UVXY going back to ~1yr after inception (so we can have 1yr rolling data points)

What scares me is that little tip there in 2018, meaning for the 1st time in this product, the 1 year rolling decay couldn't offset a vol spike (which is pretty significant given the average decay is ~80%). The main factor here is the deleverage of the ETF from 2x to 1.5x, while the same time period had the Feb 5 2018 vixtermination.  Its hard to split up how much of each factor contributed to this chart, and if they are multiplicative. (leveraged on the VIX spike, and deleveraged on the way down) 
A future vol spike will have the benefit of equal leverage on the way up and down, although that will cause the product to more closely resemble VXX 1 year rolling.

Because of the uncertainty around this, as well as the possibility of mid spike leverage changes by the funds, I still don't think we can have a constant 1yr+ duration rolling short UVXY position, so I want to wait for some amount of spike before re adding the position.

With that context, what am I doing now?

Given the mid/low VIX range at ~12/13 and SPX IVR at 0-10 this last month, I have been very active with short term calendars (~7dte/21dte) to keep a low delta/positive vega and long theta position on while waiting for a big vol move.  I've specifically been trying to take them off at 5-10% profit or at a loss when theta goes negative.

  And here is my poker metaphor for these trades-

2 types of "I've got you"...

1. I have the nuts, just salivating to see what you will bet, or if I can get a check raise.  The sense of skill is from how much can I win in this hand- trapping, etc

2. I am defending... I know from the opponents betting pattern/ranges that they probably have the nuts/ top of their range and they are salivating to see how much they can get from me.  The real skill/strategy is from seeing if I can get a free card in this hand, do everything to not get trapped and lose the minimum. When they finally bet and you insta-fold, you both know that even though you 'lost' the hand, you got them.  As the defender you more correctly assessed both hands and took their big spot that would normally be a big % of their winning session.

With these short term, at the money SPX calendars I'm specifically trying to get small wins and losses, just flip the weighted coin as much as I can.  If you are primarily used to short options/ spreads and rolling the other side/ rolling for duration, it might be harder to mentally click over to at the money delta/theta adjustments to be most capital efficient.  Ultimately I'm trying to be conscious of that 2nd bulletpoint of poker which gets lost in the 'win the maximum' $TSLA meltup we have been in.  

Thin value bets- flattening VIX delta

 Another poker metaphor, the thin value bet:  you might have top pair/ two pair on a potential straight or flush board, get checked to on the river and make a small 'value' bet in position.  If the opponent has nothing, they probably fold and you get no value, they could also be trapping with a big hand and giving you the rope to hang yourself with.  They could even call with a better 'hand that can't call' like a pair with better kicker.  The key case and point of this VIX trade is when they call with a slightly worse hand, and pay you off with the 'thin value.'

I think it was Phil Galfond who said 'if your thin value bets never get called, then you aren't thin value betting enough.'  This is where I'm starting from in this trade idea: yes we are adding some risk, but over thousands of hands (or trades), we are trying to boost expected value/yield/pot odds/whatever metaphor you're on.

This goes back to a post I made recently with VIX still in the 9s, I was examining the max monthly SVXY up moves for the product's history, looking to kind of bet on the decay 'cap' given the mechanics of /VX rolling to spot:

My finding was that with spot VIX under 10, SVXY never had a monthly gain topping 15%, which is coincidentally right around where the option chain ends on a lot of cycles.  (Almost like they are trying to tell us something).  That being said, the last strike is usually at the 15% mark, but with no strike after that, you can't create a spread to reduce buying power reduction, and for SVXY nosebleeds the liquidity/spreads are horrible so you would have to probably hold til expiration and take the hit either way.  (And obviously this 9 handle soft cap trend might not continue going forward)
On the BPR point, I was again looking at SVXY calls today and even though I have a couple hundred long deltas, it looked like there was no BPR offset (on Tastyworks at least), so a 150 short call was like 20k bpr.  (this was around the 15% mark if you are reading this in the distant future).

In the search for yield I went back into the more liquid VXX to look at the numbers with us now in the 11 handle:

Obviously there are more 15% breaches when you go from 9 to the 11 handle, but when looking further at the roll yield/roll premium/contango (/VX to spot, whatever you want to call it) for some of these days, the front month difference was more pronounced than now with usually over $1-1.50 between spot and /VX for ~30 days.

Here is one such day from the above spreadsheet where 1 month from this date VXX lost ~20%

Given the current term structure, the roll yield has been around $1 or less for the average 30 days, so that lowers the mechanical chance of an insane 15% breaching run.


Given all this I bit the bullet on VXX Feb 23 23.5/22.5 short put spreads for .12c credit, this being my thin value bet. (on 1/25/18)  Given the data its a marginal ish trade (right on the 15% decay edge and the %ROI takes a hit due to commissions at the low total premium levels unless you have some insane volume with a specific broker), but is effectively flattening my total short VIX delta at a credit.  If I have all this short VIX delta, I'm at least tickled to try to squeeze a few more drops out.

Historically I've been more scared of the VIX downside than upside (or reverse for SVXY) because with spikes it will come back but if you are long VIX it might never come back, and the only adjustment when it aggressively grinds against you is to move up your short VIX strikes and add more risk for incoming spikes.  All that being said- if this is breached,
1. it is statistically unusual, and
2. the majority of the short VIX portfolio is going to be hitting max profit way sooner and compounding as I keep rolling up and out.

Again, this is a complement to the short VIX portfolio, I am still negative delta on VIX, and the max loss to the VIX downside is only ~1/15 of my VIX spike risk.  I'm just dipping the toe in the water, so this is possibly something to leg further into.
Additionally, if you care about macro factors such as the lower dollar index and increasing bond yields and think the heavy decay of 2017 with VIX in the 11 handle might not continue with these changing conditions, this might be a reasonable idea.

Overall, this is basically a very skewed iron condor structure, but more entry specific in that we're only adding the 'long' VIX deltas with a specific futures structure and won't statically keep it on if there is a VIX spike, and the max risk is still heavily skewed to the VIX spiking side, so even a max loss on the VIX downside is still OK yield for the year.

Any thoughts friends?

Check back on the river- Another Poker metaphor

Controlled down days like yesterday which trigger all the "is this over" articles are the high point of my week or month-
While my daily P/L is down and the screen is angry and red at me, this is setting up a scenario where performance increases.
One of the trials and tribulations of rolling a constant core position (short VIX or otherwise) is the sorrow of closing at a profit means the new open position will be a worse entry, where if you roll early in a down move, you are locking in a scratch or smaller profit in order to enter at at better pot odds.  There is no core position situation where you have a great close and reopen in the same product.
(This should all be obvious but it's important to psychologically drop that bad entry/exit mindset and just think about the mechanics of the core position)

Anyway that's all a little background flavor but now that the waters are smoothing back out, I wanted to scribble down a poker metaphor that I wax poetic on and is pretty applicable to picking your risk-

If you've ever been check raised on the river in a big hand one of your gut reactions is to throw up because you have brought this upon yourself- you could always have checked back and potentially won, or just lost a smaller hand.

Here is one of hundreds of great river check raise clips-

 (I could spend all day posting Tony G videos but lets continue-) 

 Obviously these players have a huge hand history with each other and have a higher % of trapping and 'tricky' plays but in terms of a simple hand analysis, When you have Kings against two check calls on this board which has potential trips and flush, what hand is check calling you three streets that you beat? I would rather lock in a smaller win then add unnecessary risk on that river.

So what is the option metaphor?

To me this is like covered call/ Poor man covered call (diagonal) strike selection.  While we have been in a permanent bull market and backtested 30 delta covered calls are the best performers, I don't want a strategy based on that, and I'd rather set myself up with the best breakevens if things go wrong.
This is why I like ATM covered calls, (the 1st OTM strike).  If that is breached, I've locked in the call premium and the trade is a winner. I don't need more juice in those winning situations, I'd rather model an annual return on getting 2% or so monthly (or leveraged up with diagonals).  You are setting yourself up for more scenarios, and you are making your returns more consistent to model, being mostly premium/theta based than delta/direction based.

The nearest OTM strike is like checking back on the river in a big pot.  Like Tony G, if you have Kings you are already ahead of all the bluff hands and a tiny amount of weaker hands that couldn't call.  As Tony, you can just check back and win a smaller pot to fight the next day.  In the disaster scenario when Patrick is trapping with a full house, you aren't helping yourself at all to the downside, and as a trader , that is where I want and need the help!

A little Friday musing for you..

State Dependent Learning and Practice

Here is another poker/ chess metaphor-

One of my early sorrows was the futility of "practice" in many disciplines as the performance environment is so different-

• Chess or other games on the computer, then translating to a real tournament setting- different timing structure, serious and quiet atmosphere, hunger, exhaustion

• Poker on the computer, several tables, quick hands, then going to a live event- much slower, each hand is more heavily weighted, thus increased variance, similar exhaustion, competition

In cognitive science/psychology, this is State Dependent Learning, where retrieval is more efficient when you practice in the same mood/ state.

While you can get many hours of practice, you will always miss out on practicing acclimating to tournament factors. I lamented this as "pros" who play full time, almost exclusively tournaments/ professional settings, get to effectively make their 'practice' a pure tournament setting and can fully acclimate to the performance environment.
How can we improve if no matter how much we practice our mechanics, our psychology will ultimately crumble as it hasn't been exercised at all?

What does this have to do with options?

I think trading real markets takes away the "performance" setting practice edge from the 'pros'.

We are all trading the same live market, we don't trade a 'practice crash' while 'pros' are trading a real crash.
Furthermore, 'pros' are often hamstrung by institutional risk management (usually related to mega leverage, counterparty risk) and other factors that would force them to close positions that could ultimately self correct.  This can be argued as a performance setting advantage to small retail traders, as 'pros' must react to several new performance setting issues that we aren't stuck with.  In this way the professional performance setting might still be considered different, but I think we can see this setting as worse than the chess and poker examples. 

This is just my food for thought for the small guys.  The pros aren't that smart, and our life time frame is so small that we winners are all just outliers. 

Comparing to Short VIX Buy and Hold

  Shall I compare thee to a summer's day?

One of the big struggles with Short VIX is the comparison to buy and hold on XIV or SVXY, as most systems that involve signals, tactically entering/exiting, underperform.  Furthermore most of the systems that beat buy and hold from Quantopian, etc, are heavily curve over fitted, some involving straight up constant variables.

Thus one of my main bulletpoints/takeaways that I keep in mind is

 don't worry about XIV buy and hold!

When considering the massive downside risk, as well as the periods when you hit a profit target and get out/wait for reentry (such as the last ~6 months?), I think its helpful to almost think of buy and hold vs. short VIX options as apples and oranges. 

As with any option strategy, the yield curve is closer to the poker cash game graph of incremental growth over time, with big draw downs- which I mentioned in a previous article. 

I view XIV buy and hold as closer to a tournament poker yield curve, with flat periods (such as this length low VIX run we are in) followed by high yield spike periods.  To clarify, the slow dips in between "tournament cashes" on the left graph would be flat in a buy and hold strategy, as you would just be in cash with no risk during those periods. (Its a metaphor, work with me!)

To bring in a macro view- 
Many articles note the overall contraction in VIX, possibly as a result of how much trading has entered the space and could ultimately be warping it.  Another possibility is the increasing awareness of how much drag long option protection adds to a portfolio.  Or the most obvious belief that Mama Yellen will buy the dip before we are even able to.

Whatever the combined causes, as short VIX investors we must have a contingency plan for longer periods of low VIX, which a buy and hold strategy doesn't really account for.  Given that historically some of the most conservative short VIX strategies of buying XIV when VIX = 25, 20, or maybe ~16, you might only have 2-5 trades a year. 
To extrapolate further, would you be comfortable trading short VIX if you knew that the optimal trade was only once every 2 years? What about every 5 or 10? 
Where is the line where you say "ok, I will trade off theoretical yield for consistency"?  

 I recently learned chess GM Hikaru Nakamura has actually started options, and was glad to see someone else see across the domains of options, chess and poker.  For XIV buy and hold, I see this as giving up on chess because computers will always win.. don't let that stop your playing or investing! If you see computer chess as apples and oranges from human chess, devoid with fear, time trouble, self doubt, needing to draw, and more, then maybe you can extrapolate to short VIX buy and hold- a computer/model lives forever, so it doesn't care about consistency of returns, the psychology of draw downs, the self doubt of long periods with no open position, the pangs of disprized love, the law's delay, the insolence of office and the spurns that patient merit of the unworthy takes- I'm getting carried away.

Ok ok in summary- Trading is psychology, don't force another psychology on yourself if it doesn't help you!  Don't blindly lock in on "This strategy is useless if it doesn't outperform buy and hold" when they are completely different animals!  Short VIX is constantly evolving due to macro factors, and especially with the current contraction it is possible that buy and hold will be the underperformer going forward as no buy and hold strategy will be holding/entering with VIX in the 9 handle.

Ok now tweet at me for how wrong I am

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.