Monday, September 27, 2010

We're Moving!

As the two year anniversary approaches for my writing ventures here at blogspot, I've decided it's finally time to bust a move.  While blogspot has treated me well, there have always been a few features, or lack thereof, that have curtailed my creativity and hindered my ability to deliver content in the manner I want.  Moving to a more robust web hosting platform will help overcome these nuisances while giving Tyler's Trading more room to grow in the future.

Regarding location, is simply becoming www.tylerstrading.comI've now saved you time by shaving nine characters off my url.

I know.

You're welcome.

The new site is still a work in progress and you will likely see continued changes to come.  I plan to post any new content going forward within the new site versus here at blogspot.For those of you that have links to my site, please change the address to

Those subscribing to my RSS feed will need to change your subscription to the new site.  You can either head to the site and click the RSS feed icon (top right corner) or use the following link: Tyler's Trading RSS Feed.

If you see any issues or bugs that need addressed, pipe in the comment section or shoot me an e-mail:

Thursday, September 23, 2010

Low Volatility, a Siren Song?

With the VIX residing close to its lowest levels in half a year, talk of buying volatility is coming back in vogue.  While the appeal of loading the boat with long volatility strategies is understandable, be aware that this particular temptation may turn out to be a siren song.
In Greek mythology, the Sirens were three dangerous bird-women, portrayed as seductresses who lured nearby sailors with their enchanting music and voices to shipwreck on the rocky coast of their island... The term 'siren song' refers to an appeal that is hard to resist but that, if heeded, will lead to a bad result.
In the world of volatility, traders would be well served to remember that everything is relative.  Though a VIX at 22 seems cheap compared to its recent range, keep in mind the following two things:  First, the historical mean of the VIX resides right around 20 which, at the least, should make traders rethink how cheap 22 really is.  Second, and perhaps more important, the only volatility that truly matters is how much the underlying stock actually realizes throughout the duration of the trade.  And, if current market volatility is any indication as to what the future holds, not only is 22 not cheap, it's arguably expensive.

Suppose we heeded the low volatility call and purchased Oct 113 straddles on the SPY.  At a current implied volatility of 20%, the straddle is pricing in roughly a 1.26% move per day.  For those disinclined to take the percentage route, that comes out to an expected daily move of about $1.42 (roughly 2/3 of the time).  In addition, this also means we should see the occasional move in excess of $1.42 (roughly 1/3 of the time). Unless you've had your head buried in the sand, you should know we have most definitely not experienced that type of movement in recent weeks (see 10 or 21 day historical vol). 

In sum, despite the ostensibly low volatility, straddle buyers still seem to face an uphill battle.  Unless you're of the opinion that either the market movement is poised to increase notably in the coming weeks or we're on the verge of a strong directional move, straddles are not a slam dunk buy here in my humble opinion.

For related content, readers can check out:
The Tempest and Volatility Analysis
Straddles and Gamma Scalping
Gamma Scalping Inquiry
Implied Vol vs. Historical Vol

Tuesday, September 21, 2010

The Oil Angle

After spotlighting the relationship between precious metals in yesterday's The SLV Lining post, today marks yet another foray into the commodity space in an attempt to draw some meaningful conclusions. Whether it is due to my recent fixation on relative comparison charts or my monthly option plays on the United States Oil Fund (USO), I've noticed oil has been riding the pine for much of the recent bull run.  In Monday's Chart of the Week, Bill Luby of VIX and More cited the broad-based support for the market rally as virtually every  market sector was experiencing notable gains.  The same could be said regarding commodities for that matter.  In addition to the aforementioned silver and gold, we've seen a variety of agricultural commodities climb on board the bull boat as well.

So what's the deal with oil?  Not only is it not on board, it's floundering in the water unable to catch a bid.  Consider the following relative comparison chart (click to enlarge).

[Source:  Livevol Pro]

While USO did a commendable job in tracking the performance of both the SPY and GLD through the month of April, from May forward it seems to have lost its mojo.  Despite the apparent weakness in the underlying commodity, it may be important to note that most energy stocks have fared much better over the same time frame.  Both the Energy Select Sector SPDR Fund (XLE) and Oil Services HOLDRS Trust (OIH) have had much better participation in the recent rally in the equities market.

For related content, readers can check out:

Monday, September 20, 2010

The SLV Lining

With last Tuesday's breakout to all time highs, gold was thrust back into the spotlight after receiving little attention over recent weeks.  Though gold is usually the primary recipient of media attention within the commodity space, silver has been capturing some significant gains as well.  Indeed, silver, as measured by the ishares silver trust, has tripled the gains of gold over the past month (click image to enlarge).

[Source: Livevol Pro]

To exploit a continued rise in silver, how about this short put, long call spread combo suggested by the IVolatility Trading Digest Blog:

With a Historical Volatility of 18.54 and an Implied Volatility Index Mean of 29.33 for an IV/HV ratio of 1.58 and a very bullish put-call ratio of .24, consider this combination.
 In the event there is a correction in the next few weeks, there is a chance the Oct 20 put will be in-the-money and assigned.  This could be part of a plan to establish a long ETF position. In the event there is no near-term pull back then the October will expire reducing the cost on the outstanding long call spread.  However, if the correction continues back below 19, then consider unwinding.
All in all I like the structure of the play.  I'm a fan of using short puts on cheaper priced stocks particularly when one is seeking to accumulate shares of stock at a discount.  The long call spread goes out a couple months giving traders ample time for the stock to move into the meat of the spread.

For related content, readers can check out:
IVolatility Trading Digest Blog

Friday, September 17, 2010

Volatility Comparison Charts

In Livevol's newest round of software updates, they've launched yet another groundbreaking tool for option traders.  While perhaps not as revolutionary as their 3D Skew feature, the new volatility comparison charts still offer some exciting possibilities.  Though there are numerous sources you can go to that offer the ability to compare historical and implied volatility for the same security, I'm not aware of any, save Livevol, who offer the ability to perform relative comparisons on the implied volatility of different securities.  While it's true you could view multiple volatility charts side-by-side or one after the after the other to make relative comparisons, Livevol has taken it a step further allowing users the ability to overlay vol charts from several different securities simultaneously.  Consider the following chart comparing the 30 day implied volatility of RIMM versus the SPY (click image to enlarge).

 [Source:  Livevol Pro]

As I see it, viewing vol charts in this manner gives us the ability to draw quicker, more meaningful conclusions in the area of correlation.   Traders can now easier tackle questions such as...
What effect do broad market volatility trends have on the volatility of individual companies?
What are the similarities or differences between the volatility of different asset classes such as stocks, bonds, and commodities?
When do we see an individual company's volatility move in tandem with the VIX, when does it move to the beat of its own drum? 

In addition to the aforementioned volatility comparison charts, other new features of note include relative price comparison and a custom scanner allowing the ability to build scans specifying your preferred price, volume, fundamental, and volatility characteristics.  When launching Livevol Pro, it was professed "to be the new standard in option trading".  Well, mission accomplished in my book.  It is quickly becoming a one stop shop for option analytics.

For related content, readers can check out:
What Will They Think of Next?
Finding Volatility
GOOG, What Volatility Bid Up?

Wednesday, September 15, 2010

It's Settled

 Traders owning any type of bullish position going into today's VIX expiration woke up to a pleasant surprise.  Since assessing the volatility landscape in last week's The Impending VIX Expiration post, we've seen a heavy VIX continue drifting lower day by day. However, this morning's pop erased the losses of the past few days lifting the fear index up towards last Thursday's price levels.  We all know (hopefully) that settling VIX options can get a little squirrely.  Though I outlined a fairly systematic method for analyzing volatility, there is a bit of luck involved with getting a favorable settlement value.  Keep in mind however, for as many settlements that move in your favor, you will likely have an equal amount where you get shafted.  Of course, some choose to simply forego all the drama unfolding around settlement by exiting their positions beforehand.

Per the $VRO chart below, September's official settlement value came out to 22.97.  At $1.41 higher than yesterday's close and $.42 higher than this morning's opening print on the VIX, settlement certainly tilted in the favor of the bulls (click to enlarge).

[Source:  MachTrader]

For related content, readers can check out:

Tuesday, September 14, 2010

Stealth Rally

While the S&P 500 has been riding on the seemingly endless 1130-1040 merry-go-round in recent months, gold has staged a stealth rally.  Since the middle of July, dip buyers largely disenchanted by the seesaw action in equities have been welcomed with open arms by the shiny metal.
[Source:  MachTrader]

As a result of this virtually uninterrupted march higher, historical volatility has tumbled off a cliff to its lowest levels in years (8%).  Not that this is all that revealing, as just about any steady uptrend is accompanied with declining volatility.  At the same time implied vol is reticent to drop below 16% which has acted as a consistent floor over 2010. 

[Source:  Livevol Pro]
In addition to the SPDR Gold Shares shown above, we're also seeing the Market Vectors Gold Miners ETF (GDX) pop to new all time highs.  Suffice it to say, those that have stuck with the gold trade are certainly reaping their rewards.

For related content, readers can check out:
Gaming the Gold Bugs Redux

Monday, September 13, 2010

I've Got That Contrarian In Me

Given the deluge of bullish activity over recent weeks, we've seen the market traverse its entrenched trading range yet again.  Practitioners of technical analysis placing significance on support and resistance levels would assert the markets are quickly approaching a critical juncture.  Ever since the aftermath of the May Flash Crash, 1130 has acted as the proverbial ceiling in the sky curtailing each bullish advance.  Whether you argue that past is prologue and expect the bulls to once again be rebuffed, or expect this particular test to yield different results, it's tough to deny the low risk/high reward entry being proffered by Mr. Market for bearish trades.

Take the SPY for example. If your exit point sits right above resistance you're looking at about $1 to $2 risk.  Now, as for the target, I'd say bare minimum a one Average True Range drop could be in the cards.  Setting the bearish sights higher (or lower as it were), who's to say the market couldn't return back towards the lower end of its range (click image to enlarge)?  
[Source: MachTrader]
With volatility sitting at its lowest levels since before May's fireworks, we could make a compelling case that buying options may not be a bad idea around here.  So, how about entering bearish risk rocket by shorting some stock and buying puts?  Consider the following example:

For related content, readers can check out:

Friday, September 10, 2010

The Dynamics of Time Decay

When asked how to define Theta, the textbook answer is it allows traders to measure how much money an option position will make or lose per day. Though that may be adequate for an elementary understanding, there are many questions that arise when considering how time decay plays out in the real world where weekends and holidays are interspersed throughout an options life.

Having never been a market maker and never needed to generate quotes for options on a day to day basis, I must admit my understanding of the finer nuances of how time is calculated into an option's premium is certainly not as exhaustive as some. So when I received the following thoughtful question from Bill, I passed it along to Mark Wolfinger of Options for Rookies to take a stab at. Rather than post the original question, which was rather lengthy, the gist was as follows:

How does the options market account for weekends and holidays when pricing in time decay? Do options lose value over the weekend or has the weekend decay already been priced in by the close on Friday? If that's the case, does that mean options lose more value toward the end of the week relative to how much they're losing at the beginning?

The Black-Scholes and other formulas that calculate the value of an option use time as an important consideration. Time is defined as the number of days (hours, minutes, seconds, or whatever unit appeals to you) until expiration arrives. Thus, yes, you can be certain that the weekend is included in the process that determines the value of an option.

But if your question is: Will I see that time decay every day - then the answer is 'no'. Market makers set their clocks - the ones used to determine the value of an option - any way they prefer. And they prefer accelerating time prior to a weekend. When you come in Monday morning, you will never see options priced as if 3 days just passed. That decay - most, almost all, or all, has already been priced into the price of the options at the end of the prior week.

There is no set formula. Each market maker, specialist, and off-floor market maker, is free to establish his/her own program that determines the value of an option - and thus the bid/ask quote. Anyone who believes a big error has been made in the option price is free to sell the bid or pay the offer to take advantage of that 'mistake'.

[Note- This is part of the question] When I look at option pricing, there are too many factors influencing the price for me to tell the EXACT effect of theta over the weekends.

And you can never see the exact effect over the weekend. Why? Because of the way that options are priced. Each market participant gets to move the clock at whatever rate he/she sees fit. They set the bid/ask and you can trade with them, make higher bids or lower offers, but you cannot tell them how to set the clock. And the truth is that you can never know if a small change has been made to the volatility used to calculate the theoretical option values.

One simple plan is to have the clock move 7 days over the 5-day week. A more reasonable approach is to move the clock 7 days over the 5-day week, but with time accelerating during the week. Thus, it would pass much faster on Friday than on Monday. More than that, each day is not consistent, and time would pass more rapidly in the afternoon than in the morning - steadily accelerating throughout the week.

Other traders may use an algorithm that allows some passage of time over the weekend. Why? Although there is no trading, events happen, wars begin etc... Just allowing for a market-moving event makes sense. But just how much of the one week's worth of time does one devote to the weekend? I have no answer, but there's big money at stake and my wager is that the methods used to determine the clock algorithm for each trader group is a closely guarded secret.

If you take the time to look at the numbers, you will discover, all things being equal (quiet news weekend and a flat opening) the options open where they closed. There is no big price drop. In fact, it's possible for options to move up a bit in price to counter the effect of over-discounting them on the previous Friday.

For related posts, readers can check out:
Gamma vs. Theta Part I
Gamma vs. Theta Part II

Thursday, September 9, 2010

The Impending VIX Expiration

It's that time again...

Each month as expiration approaches, I habitually seek out any potential short term plays using VIX options. In identifying whether or not I have a strong enough bias worth acting on, I typically consider the following data:

Recent realized volatility of the SPX via 21 or 10 day historical vol.
The posture of the VIX index - are we close to an inflection point?
A comparison of the level of the front month future set to expire (Sept. in this case) vs. the VIX index. Is there still a notable discrepancy between the two? How much?
What option strike prices are still in play and do they offer sufficient premium to construct a position?

The underlying rationale for sticking to VIX option plays close to expiration is the increased correlation between front month futures and the Index. The higher the correlation between the two, the greater my confidence level that the futures will follow my forecast on the Index. As stated numerous times in the past, this increased correlation is driven by the fact that VIX futures converge to the Index at expiration.

So what's the current landscape look like?

Both 10 and 21 day historical volatility on the S&P 500 Index reside just north of 21%'
The VIX Index is nestled pretty close to its lower bollinger band at 22.3% - tough to say whether we're at an inflection point yet, but I would lean toward being more bullish than bearish.
Sept. VIX futures are sitting at 23.8; at a 1.5 premium to the Index, futures players are still expecting a minor increase in the VIX before next Wednesday's expiration.
If I wanted to opt for selling put options, the 22.50 ($.35 by $.40) or 24 ($1.20 by $1.30) are the two closest to the money.

[Source: MachTrader]

While the 24 strike put is a little too close for comfort, the 22.50 is lacking adequate premium. I'd prefer to see a further dip in the VIX causing the 22.50 to rise in value closer to $.60 or so. At that point, shorting puts starts to attract my attention.

For related content, readers can check out:
VIX Expiration and Term Structure
Settlin' Them VIX Options
VIX Options

Wednesday, September 8, 2010

Condor Evolution

In yesterday's post, I explored the role negative gamma plays in the evolution of a condor position. When displayed within a risk graph, it becomes readily apparent why condors thrive when mean-reversion drives market conditions. Yet another feature which helps explain a condor's frequent transformation from a non-directional to directional play is the inherent structure of the position.

The iron condor involves selling an out-of-the-money call and put spread simultaneously. Generally the deltas of each vertical spread offset each other bringing the net position delta close to neutral. In an ideal world, the stock would remain directly in between both spreads as time decay whittled away at their value. Both spreads may even approach their profit targets at similar speeds allowing you to exit the entire condor all at once. Unfortunately it rarely plays out this way in the real world. Typically the stock rises or declines affording the ability to close one side of the condor early - the put spread if the stock rises, the call spread if the stock falls.

Upon closing the winning side of the condor, trader's are left holding a directional vertical spread. When selling condors in a bullish trending market, they will likely turn into short call spreads before too long. On the other hand, when selling condors in a bearish trending market, they will likely turn into short put spreads.

In sum, though you may initiate a condor indifferent as to which way the market moves, you will quickly develop a directional bias due to the manner in which a condor changes its personality.

[Evolution Pic by Thomas Wizany]

Tuesday, September 7, 2010

The Case for the Condor

While the successful bullish defense of the 1040 level may have been met with derision from directional traders and anyone looking for a continuation of August's downtrend, there were no doubt traders who welcomed the bounce off of 1040 with open arms. Those positioning themselves to profit from range-bound action likely feel anything from calm satisfaction to extreme exhilaration on each successive failure of the bulls and bears to bust out of their range-bound prison.

We're running on about four months of ping pong action between the 1130 and 1040 key price thresholds. One of the aforementioned satisfied parties are condor traders. Condors excel in range-bound, declining volatility environments, which sums up the majority of the last few months. Though the condor initiates its profit seeking existence with a delta neutral, non-directional type personality, it can quickly become a directional player. This is due largely to its negative gamma nature.

The negative gamma aspect of condors has the effect of getting you shorter the market as it rises and longer as it falls. While this type of behavior shines when mean reversion rules the day, in trending environments where weakness begets more weakness, getting longer into dips that keep on dipping can be quite painful. Within a risk graph, delta neutral negative gamma positions, such as the condor, show up as an upside down parabola (click image to enlarge).
[Source: MachTrader]

In later posts, we'll flesh out a few more details on our flying friends.

For related content, readers can checkout:
Strangles vs. Iron Condors
Saved By The Wings
Gamma Facts

Friday, September 3, 2010

Call Spread Conversations

I received a question regarding call spreads in response to last year's Above the RIMM post. Since I've heard variations of the same question over the years, I thought it might be beneficial to outline my response in today's post.

...What I didn't really contemplate with call spreads is the time value. Let's say RIMM closes above the strike that you sold the very next day after you put on the trade. You don't reach or even come close to you max. profit do you because the trade still has time left before expiration. This seems to be the case which says to me the gain you would have would be so dismal you might as-well let the trade go on for a few weeks if its a front month contract, in order for time value to decrease.

It seems as though if I'm looking to day trade/swing trade then call options are really my best choice rather then spreads because my profit would look much better over just a day or two on the trade...

You're pretty much on track regarding how long call spreads progress. Since reaching their maximum value requires all of the extrinsic (time) value to bleed out of the option, you either have to wait until expiration or have the call spread move deep enough in-the-money until the calls are trading close to parity. So, while it's not impossible to capture the bulk of your rewards in just a few days, it's rare. If you desired to accelerate the progress of a call spread, you could simply use shorter dated options versus longer. For example, if you purchased a one month call spread versus three months and the underlying stock moved through the spread, the front month spread would rack up gains quicker.

Now, as to whether the gains will be "dismal" really depends on the magnitude of the move in the underlying stock, which expiration month you're looking at, and how many contracts you have in the position. Suffice it to say, long call spreads are not the most efficient, nor effective way to exploit short term moves in a stock. So, in that regards we are in agreement.

However, just because a long call spread isn't the most effective vehicle doesn't necessarily mean that buying call options is the "best choice" for day/swing trades. Honestly it's difficult for anyone to say what is or isn't the "best choice" as it varies from trader to trader depending upon what you're trying to accomplish. Due to the inherent trade-offs which all the option strategies the "best choice" will inevitably vary from situation to situation. If your goal was to swing for the fence by accumulating a high delta position, then I can see the allure of trading call options. Just keep in mind, they can be quite unforgiving when you're wrong.

Though purchasing call options is much more effective than call spreads when day trading, I think there are superior alternatives in the day trading arena. Since day traders are playing smaller moves in a stock, they need higher delta positions that rack up profits quick. In that regard, futures and stock are more effective. The other issue that arises with options is the wider bid/ask spread. While that may not present much of an issue if you're doing a longer term trade, it can create a large problem when day trading because you're typically playing very small moves in the stock.

For related content, readers can check out:
Call vs. Put Spreads
Call Spreads and Assignment

Wednesday, September 1, 2010

Volatility Spankin'

Due to the recent victory of the bulls in defending the 1040 level coupled with this morning's flurry of bullish activity, volatility is tumbling down from its lofty levels. Since highlighting the somewhat extreme vol levels that had arisen in last Wednesday's Fading Away post, we've seen a notable decline in the VIX to the tune of 16%. Over the same time frame, we've also seen the VXX down around 12%. This obviously bodes well for those who took last week's volatility surge as an opportunity to enter short volatility strategies. The suggested 1x3 SPY put ratio spread has not surprisingly fared quite well in this environment. In addition to the declining volatility, we've also experienced a week of time decay and a mildly bullish move in the SPY - a trifecta of positive events accelerating our profit accumulation. The current status of the spread is displayed below:

[Source: MachTrader]

The spread was originally sold for a $.95 credit and can now be exited around a $.15 debit. This particular play is not unique in its performance this week. The majority of short volatility strategies I consider when vol is high would have delivered this go around.

For related content, readers can check out:
Entering the Volatility Fray
Exiting the Volatility Fray
Ratios, Ratios, and more Ratios