Synthetic Swing Trading with Option Spreads

[wayneL]

This is not something I am doing but read in a book I bought - "Commodity Options" by Carley Garner and Paul Brittain.

It is constructed (if going long the market) by buying the ATM call, selling an OTM call, and selling an OTM put.

There are a couple of ways to look at this synthetically:

1/ A bull call spread with a naked put tacked on.
2/ A short strangle with an ATM call tacked on.

(I look at things this way to visualize possible adjustments)

I haven't got my modeller on this 'puter so no payoff diagram, you'll have to do some bloody work yourself.

The idea is to have a zero cost bull call spread paid for by the naked put, with indeterminate risk below the put strike.

Not a recomendation, but put up for discussion.

Thoughts?

 

[mazzatelli1000]

Hi Wayne,
It is great to see you back, you have been missed!!!

I am assuming that supply skew is present, so the bull call structure would benefit from that, thus the same structure in equiy/index market may not be as favourable.

Greeks are trimodal except for delta

May I ask if the ratios are 1:1:1?

 

[wayneL]

Yes 1:1:1

They did not mention skew in the book. As futures options encompass various products that may have demand or supply skew, I didn't draw any conclusions in that regard.

Playing with strikes/expiries can make some interesting scenarios. I'm not sold on it as an initial strategy, but I thought it interesting as some of my delta neutral trades end up looking a little bit like this at expiry, after adjustments.

 

[Trembling Hand]

Добро пожаловать comrade

 

[mazzatelli1000]

I assumed supply skew due to the title of the book.

I'm not sold on it either if it is to be used for swing trading as gamma gets shorter as bull deltas accumulate. At this point I'd rather hit the futures

May I ask if you trade commodity options Wayne?

 

[Grinder]

If it can be put on for a credit & you have bullish bias makes alot of sense for a swing play, even if it stays between the put & lower call strike it could be profitable. Don't like the unlimmited risk on the downside past the put though, makes me shudder if you get the direction completely wrong & the sp tanks.

What would you defend such a move?

 

[wayneL]

I assumed supply skew due to the title of the book.

I'm not sold on it either if it is to be used for swing trading as gamma gets shorter as bull deltas accumulate. At this point I'd rather hit the futures

The debit free trade above the put strike only applies at expiry as well.

Futures win for swing trading - agree... apart from when the planets line up for options.

May I ask if you trade commodity options Wayne?

Yes I like what Stuart Johnston calls the Non-Seasonal trade. i.e. sell options on the safe side of seasonal tendencies, with a strong reference to historical moves.

As commodities tend to stay in a defined range most of the time, it works well. Just have to avoid suicide seasonals, those times of the year when the counter seasonal move can be vicious... like when weather events can spawn black swans.

 

[wayneL]

Добро пожаловать comrade

длиной живет виток, друг.

 

[prawn_86]

I thought this was an english site :

 

[wayneL]

If it can be put on for a credit & you have bullish bias makes alot of sense for a swing play, even if it stays between the put & lower call strike it could be profitable. Don't like the unlimmited risk on the downside past the put though, makes me shudder if you get the direction completely wrong & the sp tanks.

What would you defend such a move?

You would want to flip your delta PDQ. To me, as discussed above, it seem to go against the concept of swing trading, ie get in, special forces style, take what profit you can and get out... and scurry back into hiding if they know you're coming.

 

[wayneL]

I thought this was an english site :

Not much English spoken where I'm living. Almost all Italian and French, some Poles...

... lot's of Suth Ifricins... but that not really English, is it?

 

[Grinder]

You would want to flip your delta PDQ. To me, as discussed above, it seem to go against the concept of swing trading, ie get in, special forces style, take what profit you can and get out... and scurry back into hiding if they know you're coming.

night stalking is'nt my style, think I'll stick with master & commander where I can manage my vessels from afar.

 

[mazzatelli1000]

Yes I like what Stuart Johnston calls the Non-Seasonal trade. i.e. sell options on the safe side of seasonal tendencies, with a strong reference to historical moves.

As commodities tend to stay in a defined range most of the time, it works well. Just have to avoid suicide seasonals, those times of the year when the counter seasonal move can be vicious... like when weather events can spawn black swans.

Awesome, thanks for sharing!!

It wasn't til recently I saw some research published about local vol surfaces for commodity options that piqued my interest. Up until now it was just equity/index and FX space
It looks like your using stat vol as your forward basis?! Ill continue exploring.

Maybe Ill take up a degree in meteorology just for these---LOL jk

 

[wayneL]

Awesome, thanks for sharing!!

It wasn't til recently I saw some research published about local vol surfaces for commodity options that piqued my interest. Up until now it was just equity/index and FX space
It looks like your using stat vol as your forward basis?! Ill continue exploring.

Maybe Ill take up a degree in meteorology just for these---LOL jk

Here is the book I got that idea from Mazza: http://www.amazon.co.uk/Trading-Opt...=sr_1_1?ie=UTF8&s=books&qid=1246270316&sr=8-1

Stuie is an entertaining guy and there is some really interesting thinking in there.

*recommended reading IMO

Not really stat vol (athough structural vol a consideration), but straight out statistical info.

eg

• What appears to be the minimum value for the commodity
• When and where are the seasonal tendencies
• If the seasonal tendency fails, how much does it tend to move against it
• What is the historical MAE against the current price in the time period in question
• Can I get enough premium to justify a trade in a WOOM non-seasonal write
• What is the suicide season where weather events can blow up the chart and possibly my written position (such as the possibility of frost in Brazil (making my machiatto more expensive) or hurricanes in florida etc)
• ETC ETC

When the planets line up, straight out written options are such a high probability trade, it's almost immoral )

There is a chapter in the book on defence too, interestingly titled "Apocalypse Never".

Those with a good sense of the absurd will get a few belly laughs too.

 

[emilov]

Hey, about that trade. It does make sense to do it like this but there is better. So you are doing a bull call spread and short put (both of which limit you on the upside, but not on the down side).

Why not instead turn it around and do a bull put and a long call. The bull put finances the long call, you have unlimited upside profit but limited loss on the down side. It's a protected collar so to speak.

My 2 cents

 

[mazzatelli1000]

Hey, about that trade. It does make sense to do it like this but there is better. So you are doing a bull call spread and short put (both of which limit you on the upside, but not on the down side).

Why not instead turn it around and do a bull put and a long call. The bull put finances the long call, you have unlimited upside profit but limited loss on the down side. It's a protected collar so to speak.

My 2 cents

What strikes are you playing with? Perhaps an example

 

[emilov]

ok sure, now follows the generic disclaimer about general advice and bla bla

You can spin this quite using various strikes. Let's say TLS was trading at 3.35 (which is what it is trading for right this second) and you are convinced it is going to explode on the upside (it won't but lets not go there).

You could then sell a 3.36$ put, buy a 3.12 put (bull put spread) and buy a 3.36$ call (or a higher strike if you anticipate a strong move). You'll still end up with a debit for the whole trade (credit for bull put, debit for the call), but it will be small. As for expiry, you can go the current month (reacts faster, but time decay hitting it badly) but better give yourself more time, so next month. The max margin will be 24c per contract, partially offset by the bought call.

There is another much cooler way to spin it that almost zeroes your margin. You do the three legs but all the same strike, say 3.36$. But for the sold put you go one month further out, so bigger credit. As long as you get rid of it before the bought put expires the margin will be almost zero, after that it will kick in hard.

So when the stock takes off you make money on the call and on the bull put (which is a credit spread and gets smaller as time decays and stock moves up).

If you are really gutsy, drop the protection of the bought put, just buy a call and sell a put (reverse collar). But this will make the margin for the naked put run wild. So the protection gives you both, less margin AND protection from the unlimited downside loss.

 

[mazzatelli1000]

You can spin this quite using various strikes. Let's say TLS was trading at 3.35 (which is what it is trading for right this second) and you are convinced it is going to explode on the upside (it won't but lets not go there).

You could then sell a 3.36$ put, buy a 3.12 put (bull put spread) and buy a 3.36$ call (or a higher strike if you anticipate a strong move). You'll still end up with a debit for the whole trade (credit for bull put, debit for the call), but it will be small. As for expiry, you can go the current month (reacts faster, but time decay hitting it badly) but better give yourself more time, so next month. The max margin will be 24c per contract, partially offset by the bought call.

My Dissection:

The $3.36 short put and long call combo becomes a synthetic long.
Combine that with a $3.12 put and you have a synthetic long call for $3.12

Extra transaction costs and even if the long $3.12 call was traded outright, tankage in vol line associated with bull deltas would still make me inclined to trade the spot.

There is another much cooler way to spin it that almost zeroes your margin. You do the three legs but all the same strike, say 3.36$. But for the sold put you go one month further out, so bigger credit. As long as you get rid of it before the bought put expires the margin will be almost zero, after that it will kick in hard.

Possible dissections (if this is right long $3.36 June Call, long June $3.36 put, short $3.36 July put):
1) Reverse June/July Put Calendar $3.36 + long June call $3.36
2) June $3.36 straddle + short July $3.36 put

Either way, I would prefer vols to be high for this play due to back month vega, and possibly will have to gamma trade the front month longs. So not a swing trading vehicle IMO

If you are really gutsy, drop the protection of the bought put, just buy a call and sell a put (reverse collar)

What strikes are you refering to here for clarification?
None of the above states you are wrong btw

 

[emilov]

You are correct, sold put & bought call => synthetic long (also called a reverse collar). Adding the bought put decreases your credit but it protects from higher margin and losses on the down side. The bull put itself helps to offset (at least partially) the time decay of the bought call.

So, if you do just the synthetic long with no protection, you either do both close to the money, or first out of the money. But since we don't have guaranteed stop losses here in Australia I find that strategy too risky for me, hence the protection.

(and of course, this thing works as a short too i.e. bear call + bought put)

 

[mazzatelli1000]

You are correct, sold put & bought call => synthetic long (also called a reverse collar).

Wrong
The strikes you have stated are $3.36 short put and long call - this is a synthetic long
A reverse collar is short an OTM put and long OTM call - an example would be short the $3 put and long the $4 call

Adding the bought put decreases your credit but it protects from higher margin and losses on the down side. The bull put itself helps to offset (at least partially) the time decay of the bought call.

You would be purchasing a synthetic ITM call $3.12, not much time decay. The bull put creates that illusion.

Nice thinking though