Strangles and straddles:
If your looking for a big market move but dont know which direction, this strategy is best emloyed during
low market volatility, if buying the position. Here again, PFX has one or two videos about this trade.
Faith consists in believing when it is beyond the power
of reason to believe.
Voltaire
Delta Neutral Trading
Spot / Option Hedge:
This stategy employs a spot position combined with an options position.
1) 1 mini spot position (10,000 USD) is roughly equal to 1 option contract (exchange traded)
2) a spot position always has a delta of 1 (for each 1 pip move, your equity is adjusted by $1)
3) an ATM option position has a delta of near .50 (for each 1 pip move, your equity is adjusted by $.50)
4) to create a delta neutral trade, the combined deltas of the option positions must equall zero ( +1 long
position and -1 short position )
TRADE SETUP EXAMPLE :
enter short USD/JPY 1 mini contract or 10,000USD notional
enter long YUK 2 ATM contracts (2 x delta .50 = delta 1) or
enter long YUK 4 OTM contracts (4 x delta .25 = delta 1)
aprox cost of trade $200 or roughly 200 pips
If we purchase the options 1 month out, we have 1 month for this pair to move 200 pips.
POSSIBLE OUTCOMES :
I cant cover all possible outcomes, you can enter / exit these positions at any time, also you can enter
/ exit partial positions.Here are a few scenerios:
1) if the pair stays within the 200 pip range, time will erode your option premium, if the pair is exactly
at the price you entered after 30 days, then you incurr your maximum loss of $200 (whih is what you paid for the options),
and the spot position will break even.
2) if the pair moves up 500 pips within the month, you will incurr a $500 loss on your spot position. Your
option positions would now be worth in the neighborhood of $800 for a net gain of $300.
3) if the pair moves down 500 pips within the month, your option positions would be worthless (at expiration)
for a loss of $200. Your spot position would be up $500 for a net gain of $300.
At almost any other time or price interval during this trade, you can work this position to turn a profit.
Your maximum loss on the option positions is $200, however the option positions will maintain some time
value throughout the trade. As the option positions move into the money, the delta values will increase ( pay attention...this
is the key to the trade) to the point where each option contract could be paying you near a delta of 1. If you
have 2 option contracts with a delta of 1, you are now getting $2 for each 1 pip move. This is not even taking into consideation
the rise in implied volatility ( were you paying attention on the previous page of this website).
If you have a bias as to which way the pair will move ( you should have a bias due to your fundamental and
technical analysis skills) you would play the options in your preferred directional bias assuming you are buying at low volatility.
This trade is a no brainer...enter during low volatility when you are expecting a big market
move...either way you win...all the above values should be times 10 , if you are properly funded, if not, the option comissions
will affect your bottom line.
If you understand the greeks, this is a gamma trade. Gamma is the expected movement of delta. It is why
the trade works, it is the skew in the option pricing model ( refer to last page , this is what I was talking about).
This link explains the spot / option delta neutral hedge :
they are making this trade in reverse.....gamma is working against you with a short option
position. They should be short spot / long call or long spot / long put. You need to be long the option position for gamma
to be working for you.
Dynamic Hedging :
Constantly monitor the above position, maintaining a delta of zero, and taking small profits
( this would work very well if the trade is interest positive )
Find "Dynamic Hedging" within this link:
The years teach much which the days never
knew.
Ralph Waldo Emerson
My think OUT OF THE BOX trade:
This trade is a combination of a call spread and a calendar spread. You wont find it on any broker platform
where they post numerous canned trades. There are many variations of this trade and many nuances.
Once the trade has been set up, we need an option analysis program to fine tune it. An excellent (and free)
analyzer is offered by "Samoa Sky". http://www.samoasky.com/
You cannot effectively set this trade up without the graphical software these services provide.
OK here is your very basic trade setup:
you should have a neutral to bulish outlook on the market or more specifically short term neutral
to bearish , longer term bullish
1) sell the front month , near the money call, the delta should be near .50 and the implied volatility should
be high in rlation to the calls we are going to buy
2) buy 2 calls one month out with a delta of aound .25, you should be close to delta neutral on this trade,
the 2 calls you are buying shold have an implied volatility of much less than the call you sold.
you should be close to market neutral as far as price is concerned, the price of the call you sold should
roughly equall the cost of the 2 calls you bought, so this should be very close to a free trade, maybe a small credit or debit.
If the market remains relatively quiet, the call you sold will expire worthless leaving you with 2 call
options with 1 month till expiration that you did not pay for.
If the market goes down, the call you sold will expire worthless, again leaving you with 2 free call options
with time value remaining.
If the market begins to make a strong move up, you will need to buy back the call you sold for a small loss
and allow the 2 calls you bought to get you in the money
The only way to screw this trade up is to fall asleep for a month.
On the other hand, a fool can find a way, and this fool has.
Please Note :
These trades must be set up correctly utilizing all available analysis:
1) spot analysis
2) option chain analysis
3) volatility analysis
4) risk graph analysis
Keep your eye on the ball, and swing !
