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smjohnson8256


Total Posts: 7
Joined: Jan 2015
 
Posted: 2019-09-10 12:54
Hi,

I am struggling with a rather basic trading question. Please help!

I got myself 7 years of EOD data for options on the german DAX (symbol ODAX + weekly options; european style). Then computed the P/L for each option if held to expiration. I focus on the very near expiration time frame (let's say: 5 days to exp.)

Not surprisingly, I found that bid and ask quotes for 2% and 5% OTM puts were both "too high" (in the sense that selling the puts at the bid price results in P/L>0).

Let's suppose I wanted to profit from selling the 2% OTM put at the bid. How would I go about hedging such a position against catastrophe (crash)? As it turns out, I cannot do it buying the 5% OTM put at the ask, because this ruins the overall P/L.

Any suggestions for a poor newbie?

nikol


Total Posts: 784
Joined: Jun 2005
 
Posted: 2019-09-10 14:52
Hint: think about put-call parity : C-P = F-Coupon

Baltazar


Total Posts: 1773
Joined: Jul 2004
 
Posted: 2019-09-10 21:34
You could think about a dynamic trading strategy:
If the DAX drops more than x%, I buy these back.
(Accounting for jump risk.)
Maybe there is money left.
Or simply sell these options when conditions seems favourable instead of 'all the time'.
This is what short skew strategy is.

And also take a step back: these are expensive options because they cover a risk, a risk of crash.
If you sell them and hedge away that risk, it is likely that nothing is left. Or worse if these options are the cheapest way to hedge that risk.



Qui fait le malin tombe dans le ravin

smjohnson8256


Total Posts: 7
Joined: Jan 2015
 
Posted: 2019-09-12 11:23
Baltazar, thanks!

Of course, I know the reasoning that OTM puts on a stock index are "overpriced" 99.9% of the time to cover the huge losses resulting from the 0.1% crash events.
But on the other hand there are good reasons why OTM puts might be overpriced even in the very long run (including periods of crash): lots of "insurance buyers" facing a small number of insurance provider.

Concerning the short skew strategy: I admit that I have not done enough research on this. I'll put it on my to do list.
If you could point me to a good reference (preferably plain english, not hard core math), it would be appreciated.

Concerning the selective trade strategy: I have conducted a little experiment on this inspired by Sinclairs 'Vola trading' book. Used the german stock Bayer (BAY).
Maybe I am too dumb, but in a 4 year period I was unable to spot the situations where selling options was a sure winner (from an ex ante perspective, programmatically, of course).
I based the trades on the relationship historical<-->implied vola (all sorts of indicators) as suggested by many folks but there simply was no clear-cut image. Disappointing.
This was exactly why I turned to markets where, supposedly, there is an edge in the average trade (not situation dependent).

smjohnson8256


Total Posts: 7
Joined: Jan 2015
 
Posted: 2019-09-12 12:16
Nikol, thanks for your input!
Are you aiming at the ITM call with the same strike as the far OTM put I used as a hedge (long put)?
So, you mean buying this call and go short the DAX future?
I calculated P/L for a same strike P/C pair 3-4% below the current DAX, again 5 days to exp.
About 500 data points.

It seems that the bid for the call is below the fair value, and the ask is way too high.
So buying this call will probably end up in a loss, even if you buy at the mid price.

Can you give me some more hints, please?

nikol


Total Posts: 784
Joined: Jun 2005
 
Posted: 2019-09-12 14:12
Description is a bit messy.
Can you put specific numbers as examples?

put bid/ask (for 2% 5%)
call bid/ask (same)
fut bid/ask

Draw pictures like (visual helps):
sell_put (at bid) / buy_call (at ask? maybe try improving bid? ) / sell_fut (ask) => any arb?
etc.

Ask yourself, where is most of liquidity located? ITM calls or OTM puts same strike?

"bid for the call is below the fair value, and the ask is way too high."
Is it about ITM calls, right?

PS. There are a number of arbitrage conditions. You can try to googling 'static arbitrage bounds' or 'constrains'.

smjohnson8256


Total Posts: 7
Joined: Jan 2015
 
Posted: 2019-09-12 15:02
Yes.

--------------------
"bid for the call is below the fair value, and the ask is way too high."
Is it about ITM calls, right?

nikol


Total Posts: 784
Joined: Jun 2005
 
Posted: 2019-09-12 15:44
Perhaps, there is a reason for that - nobody wants plain exposure 1 week before maturity. This wide spread embeds jumps too.

Maybe open little betting machinery (mobile app) selling 1 week binaries and then use them as a hedge for your OTM puts )) ? -

It will take a while to get the volume in but you will solve your problem.

gaj


Total Posts: 49
Joined: Apr 2018
 
Posted: 2019-09-12 17:43
The last 7 years have been relatively tame. If you go back to 2008, selling puts wouldn't look as good. I believe OTM puts are still rich in the long run, but 7 years is probably not enough to prove it.

Echoing Baltazar, I don't believe there is a way to hedge the risk and lock in the profit. There is a premium because you're selling an insurance. If you try to hedge, you're buying back the insurance and giving up the premium.

deeds


Total Posts: 448
Joined: Dec 2008
 
Posted: 2019-09-13 11:28
@n thank you for your excellent posts over the last year

in principle, app is a very interesting idea...seems like it would be enmeshed in regulatory mosaic of jurisdictions which treat binaries as gambling vs investment and have various levels of compliance requirements...bucket shops aren't really allowed

In proposing such a thing are you talking to a bank, large fund, or do you see this as something an entrepreneur could feasibly achieve? Under what circumstances can one ebay financial contracts?

Really awesome idea, nanonarrow market making / insurance / gambling...can nichetarget engaged investors...

EDIT: and think of the picks and shovels!

smjohnson8256


Total Posts: 7
Joined: Jan 2015
 
Posted: 2019-09-13 13:32
Nikol, here are some specific numbers.
Dax options, 2012-2018, 304 trades, each time put on 4 days before expiration.

--short put, 3-4% OTM--------------
mean bid and ask 8.227632 10.846711
P/L if sold at bid
Min. 1st Qu. Median Mean 3rd Qu. Max.
-265.500 2.500 4.600 1.754 9.625 63.590

--long put, 5-6% OTM--------------
mean bid and ask 4.076645 6.582895
P/L if bought at ask
Min. 1st Qu. Median Mean 3rd Qu. Max.
-98.100 -6.725 -3.800 -5.795 -2.500 121.900

--long call, 5-6% ITM, same strike as long put--------------
mean bid and ask 540.4039 571.6753
P/L if bought at ask
Min. 1st Qu. Median Mean 3rd Qu. Max.
-781.300 -106.400 22.910 -8.948 123.400 416.400

smjohnson8256


Total Posts: 7
Joined: Jan 2015
 
Posted: 2019-09-13 15:19
mean dax, mean sputstrike, lputstrike, mean callstrike
10483.606 10096.875 9924.671 9924.671

nikol


Total Posts: 784
Joined: Jun 2005
 
Posted: 2019-09-13 15:43
Not what I expected to see. No need those P/L figures.

But anyway, see example:
sell OTM 3-4% put at 8.2 => short 3-4% put position + 8.2 cash
(scenario: maybe be you can wait and sell it at 10.8, so you get 10.8 cash)

buy OTM 5-6% put at 6.7 (?) => long 5-6% put position - 6.6 cash.
(scenario: maybe be you can wait and buy it at lower price, so you spend 4.1 cash)

depending on the time you wait in both trades you might get from 1.6 to 6.7 in cash, while you have on your book straddle
long 5-6% put and short 3-4% put.

1.6 - 6.7 is your 'sales' (+). Your costs (-) side is potential loss from short position capped with long put. And still you have quite visible chance of loosing (those negative numbers at Min P/L).

Note, that Long call 3-4%,Short futures needs more upfront capital than simple Short put 3-4%.

And, yes, reread what Baltazar says - there is no free lunch.

However, to not discourage you, I recommend to try it with small amount of money or you can do real life paper trading in the excel.xls by setting up position at time=0 entering prices, looking evolution of PnL, closing position at end of the week and thinking about all kinds of "what ifs" while doing end of day risk management.
You will gain huge experience.

Warning:
I am a bit surprised with relationship of prices, but how can it be that:

price of 3-4% put > price of 5-6% put ? Are you sure?

To clarify definition: 3% Put has a strike = spot*0.03, right ?

nikol


Total Posts: 784
Joined: Jun 2005
 
Posted: 2019-09-13 15:49
@deeds

Once I was asked to opine on app with 5min/15min/30min maturing binaries on Crypto.
Looks really addictive.

I regularly receive calls from binary sales and enjoy those talks a lot, by asking questions about which model they use, greeks, and finally "Hey, 1 min ago you promised me that I never loose; can you put a margin on escrow account to guarantee that?".

deeds


Total Posts: 448
Joined: Dec 2008
 
Posted: 2019-09-13 16:21
Thanks, @n,

Would expect business plan for a crypto binary app to include eventual regulation (in the industry survival scenario)...'twas so?

To confirm, these salesguys' and firms are probably licensed and registered?

I would think even for gambling the app would be subject to regulation...certain it's true of W.Hill, etc

nikol


Total Posts: 784
Joined: Jun 2005
 
Posted: 2019-09-13 20:06
Binary sales is plain scam to my opinion. I just had fun.

App would be banned under gambling law if it were about fiat.
I made couple of remarks and departed these guys to have no link between us whatsoever.
Thinking: On the other side, what is the crime about letting people gamble with tokens named BlablaCoin on derivatives on let say Bitcoin? This process is called - "gamification". Of course, there are more useful ideas than just gambling.


Still, my general perception is that crypto will become regulated at some point and quite a number of businesses and people will be punished retroactively. "Big Brother is upon us".

smjohnson8256


Total Posts: 7
Joined: Jan 2015
 
Posted: 2019-09-14 10:00
No.
3% OTM put was supposed to mean strike = spot * 0.97
See my post 2019-09-13 15:19

x% meant x% below spot
--------------
To clarify definition: 3% Put has a strike = spot*0.03, right ?

nikol


Total Posts: 784
Joined: Jun 2005
 
Posted: 2019-09-14 10:57
ah. ok.

you> I cannot do it buying the 5% OTM put at the ask, because this ruins the overall P/L.

My suggestion was to check synthetic OTM x% put replacing it with ITM %x call - Fut. You said it is even more expensive. Perhaps, this is it.

However, if you really observe anomaly, try to sell expensive synthetic and hedge it with real put? Dont forget transaction cost.

Baltazar says that you should involve dynamics, i.e. try to predict and enter at most optimal moment.

Good luck.

deeds


Total Posts: 448
Joined: Dec 2008
 
Posted: 2019-09-16 17:23

"On the other side, what is the crime about letting people gamble with tokens named BlablaCoin on derivatives on let say Bitcoin? This process is called - "gamification". Of course, there are more useful ideas than just gambling."

where gamification includes the exchange of cash for contracts (or creating a platform for it) i think there will be regulation and so probably there will be some crimes, and not a few accidental

agree about crypto, but i can't help wondering what that will look like...an IETF/ICANN of currency?

nikol


Total Posts: 784
Joined: Jun 2005
 
Posted: 2019-09-16 17:39
Indeed, but if to generalize one can see few layers of legality here:
1. fiat vs bitcoin : exchange
2. bitcoin vs token (coin) : exchange
3. token : gambling

Level-3 is anything like game. One can buy castles, tools, weapons inside it with gambled tokens.
Then, someone organizes exchange of tokens to bitcoin (or any other popular coins).

Where is a border?

deeds


Total Posts: 448
Joined: Dec 2008
 
Posted: 2019-09-16 17:58

Service has been provided in creating virtual object, value has been agreed

(coincidentally, to the tune of $93 b last year, October Harpers Index tells me)

i think in almost all jurisdictions regulation is applicable when enterprise involves a game of chance or a wager or game which is not 100% skill (and I am wondering about 100% skill...)...could we find a line at fantasy football? In November 2018 NY ruled that the state could not regulate....clearly its a temporal as well as operational dynamic (things will be fluid, especially around the holy cyber-scrip)
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