For a option trader, Friday was a unique day; market "hard" down and no move in the VIX. I will show in a minute how that worked out for my trade. But lets start with a basic introduction of the page I copy from my broker platform (ThinkorSwim), since not everyone is with TOS and not everyone trade options on a daily basis.
The page I copy, in this post, is the analyze page. This page is built up in three section. The top section shows the Profit and Loss graph. The middle section shows my position risk expressed in terms of option Greeks. The bottom part show you which options are part of my position.
The P/L section shows the Profit/loss graph for expiration day in red and for the current day (t0) in white.
Tos allows to do "what if" games with the analyze page; what would happen to the graph and P/L if the volatility moves up with x points. What happens when we move time a couple of days. Or combination of those two. At the end of the day just before the close I will run through a couple of those scenarios just to see how my position (in theory) will hold up the next day. If necessary I will make a minor adjustment to compensate for a market running to close to the edge (the expiration Break Evens).
The middle section show the options greeks for today for the current price (live) and if the market would move 1sd up or down. I am going to be brief on greeks, if you need more do a search on Google. In short; Delta and Gamma is the directional risk. Vega is my risk associated with a moving Implied Volatily and Theta is the estimated time decay of one day. Theta is my daily pay check. Today my vega is -304 which says that if the RUT IV moves one point up. I loss $304 and if the RUT IV moves one point down, I will make $304.
Today my delta is -3 which is extremely "flat" no directional risk. Yesterday the delta was -22 which means for every RUT point we go down. I make $22. Gamma is a factor which expresses how the delta of the position is changing. Yesterday the gamma was 1.18. This means in short and with a broad brush. That for the first RUT point down I made $22. For the next rut point down I made $22-1.18. For the 3rd RUT point down I made $22-1.18-1.18. Etc etc. This continues till the delta isn't short anymore and then I will lose the delta in $ per point if we continue down. Gamma is not a stable number it will increase over time and as you see today it also increase when we get closer to the edge of the trade. It is Gamma which makes the T0 graph have a slope.
Today was unique because we went down and the IV was flat. Since I started with a negative delta position and a negative vega position. I gained the "delta profit" and was not punished for an increase in IV. This doesn't happen often but it is the 2nd time this year.
Lets finish up for today with the questions from Px;
1. I like to look at current ATM implied volatility for the RUT and calculate what the expected move for the RUT is till expiration. Current 42 point up or down. Then I will round up to the next strike. Since this trade only to be active for approx 15-20 days, 50 wide should give me a reasonable safety margin. (Plus there is a plan if we have bigger moves).1. my question at this point would be what's the rule for selecting the border numbers in this case are 770 and 870? (from the charts, looks 870 --> recent top and 770 in Apr--> recent low in Jan).
2. Also, is there a best entry point, e.g, waiting until RUT comes around middle of two borders (in this case, (870 - 770)/2 + 770 = 830) or when its premium increased? .
3. I would also like to know additional selecting conditions for iron-butterfly trading candidates, e.g., do we need to find high/high liquidity volatile securities? positioning or avoiding for ERs ? etc.
2. With hindsight there is of course a optimum entry point. I look for an entry point in the range of 45-30 days before expiration. And as a personal style I like to enter when I (think to) see an intermediate top in a confirmed uptrend. It is not that you can't trade these in other markets - and if I don't find my favorite spot I will enter just based on time. This with the exception when the VIX signals market panic, then I will wait till I see a confirmed downward trend in the vix.
3. Highly liquid, multiple exchanges, electronically traded, broad based indexes. For this "bread and butter" kind of trade only the RUT and NDX count. The spx is open outcry, good to trade in normal market conditions, but during panic hours the SPX pit will not see my complex order and I will get run over by GS and MS. The SOX is not liquid enough and trades only on PhlX, nothing against PHLX, but if one echange has the monopoly of the option price you will see strange things during hours of panic. The rest of the broad based index are disqualified (for me) for similar reasons. For this style of trade I stay away from individual stocks, because I am not interested in carrying the risk of a merger or naked-photo of the CEO on his twitter account.
This is it for the weekend, as said before come out of hiding if you have questions. BTW I am Dutch (and live in NY) so excuse my grammar. I don't have time to reread it tonight, I will correct the most obvious errors tomorrow.
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