First some business:
We are bringing back our special LIVE look in, one week from Thursday. Like last time, it will focus on weekly options. You can register here.
Now the Post:
This is straight from one of my option mentoring students. We have been working on back spreads and straddles, on Mar 23rd the student thought that MA vol was looking ripe for a straddle play. I can't disagree with him, it had two characteristics that I like in straddles low vol:
Notice that MA was 30 Day IV was hitting near a 6 month low in implied volatility. At the same time the stock was hitting a near term low as well. This is a great combo for straddles because a combo of low vol and low price almost always leads to market movement in one direction or another.
The trader bought the 5 July 245 straddle for around 31.00. If we consider the time for that movement, a decent buy. After all, we don't need 31 dollars of movement, just some quick movement AWAY from 245. As you can see, MA rallied, and rallied quite hard.
On April 12th with MA trading near 265 the trader was long about 200 deltas. This is where the ship sank. One of the important thing to remember about the word scalp is that it implied that we are removing risk. This trader did remove some delta risk, but added a lot more risk. He bought the 3 May 260 puts for around 8.60; the trader reduced one risk to create another:
This is why gamma scalping can be so difficult. It is hard to tell what is a good scalp. In this case, while he cut delta he added to theta, vega, gamma. All bad bad ideas. Rather than buying options the trader should have made it a point to SELL options. He could have
1. sold a couple of the 275 calls in May
2. Sold some June upside calls
3. Sold some stock
4. Sold some of his July 245 calls
5. One interesting trade that I kind of like is to do a delta negative ratio back spread. In this trade we might sell the May 255 calls and buy 2 of the May 270 calls against it. Then If MA rallied we would actually begin to get LONGER deltas and make money.-warning this approach takes a ton of skill and can be botched pretty easily.
Any of these combinations is a winner. The key is that in scalping, just like in adjusting a position the goal should not be just to cut delta, it should be to cut risk. Stock cuts delta, without changing Greeks, short calls cut delta, gamma and theta that is why these adjustments work. This student missed that part of the angle. Needless to say, MA continued to rally, these options lost all of their premium. While his straddle is making about 700 dollars today, the puts that he bought to cover the position are almost worthless, net he is down almost 2k from those sucker. As we get closer to expiration they hedge delta less and less. Once May rolls off any hedge they offered is gone.
If he wants to stay in his straddle he will have to find a new way to adjust, might I suggest selling something?
I would like to thank him for letting me rip apart his trade on the internet, he is quite brave.
Those interested in ETF's should be sure to check out my newest 4-Week webinar: 'Trading ETF's in a Volatile Market.' The course if fully refundable if you open a new tradeMONSTER account, it also can be discounted for existing tradeMONSTER customers. You can review the whole course along with all our upcoming events here.
Anniversary month is over, but if you are looking to be a Level 2 or 3 students, we are still here to help you learn to trader. Heck, simply following the SPX trade I threw out on this blog Monday would have paid for several months of L1 membership. Dial (888) Trade-01 or email me mark@optionpit.com for more info.
I will be speaking LIVE at the CBOE on May 7th. The subject is trading the VIX. It will be a perfect follow up to my presentation on Wednesday. This is perfect opportunity to support this blog by learning about a subject you probably care about anyway. Register here: VIX
