Best way to

Discussion in 'General Discussion' started by N N, Feb 5, 2016.

  1. N N

    N N Well-Known Member

    I wanted to start a conversation on what would be the "best" method to trade a short term bounce in a particular stock or index. In other words "Catch a Falling Knife" I'm speaking specifically of the August market selloff and and the recent one in January, but hopefully this can apply to individual stocks as well. In particular, we know timing the bottom is near impossible to do consistently, yes I know all about Technicals and Supports etc but let's assume we had no idea. Just that if market goes down 5% we want to trade a retracement and not get killed trying to catch a falling knife.

    I would assume our conversation will start with either calendars or butterfly's, with some positive delta. The exact location will vary depending on entry and each scenario so not much point in discussing that. Our duration will be probably be < 30 days. We know front month IV will rise relative to back month IV making calendars more interesting. We also know that IV will revert (esp in 30 day back month) so this would benefit the Butterfly more. A Longer term butterfly has more exposure to IV so since a bounce will have declining IV, should we put on a longer dated Bfly?

    I've tested calendars on individual stocks (CMG recently) with very short term near month (1-2 weeks) and very long back months (6-12 Months) and these perform well but have a good amount of delta exposure. And relatively speaking the 6m+ IV doesn't rise AS MUCH but it does still suffer. I'm sure there are scenarios where it could! I haven't looked at fly's in as much detail.

    So any thoughts? Any real life experiences?
    Last edited: Feb 5, 2016
  2. N N

    N N Well-Known Member

    As of the time of this writing the SPX is at 1844. If we want to play a bounce to a MA, I used 9ema, that would be ~1890. Here are the following markets:

    FEB/MAR2 1890 MAR Call Calendar @ 16 mid. DTE is 10 & 32 respectively, IV is 24.5 & 22.3 so the term structure is in our favor.
    MAR2 1850/1900/1950 Fly @ 8.60 mid (32 DTE) - 24.6/22/20 IV respectively
    FEB 1850/1900/1950 Fly @ 12.60 mid (10 DTE) - 25/23/21.7 IV

    I have no idea where we bounce, maybe today, maybe from 100 points lower. I want to plan for 100 points lower and I'd like to test a scaled in approach. The 10 DTE fly seems aggressive timing wise but we SHOULD bounce in 10 days, the timing of the fly will be tricky. The calendar OTH has term structure working for it and if the FEB expires worthless, easier to short another front month and/or scale. Scaling fly's can seem a bit unwieldy.

    I assume those with OptionsVue etc can backtest but unfortunately I don't have it as of yet so doing testing by hand.
  3. N N

    N N Well-Known Member

    FEB/MAR2 1890 Calendar is 17.75 <--- Interesting!
    MAR2 1850/1900/1950 Fly @ 8.85
    FEB 1850/1900/1950 Fly @ 11.40

    Only the FEB fly is negative, the MAR is even and the calendar is showing almost 10% profit with SPX lower than entry
  4. N N

    N N Well-Known Member

    FEB/MAR2 @ 22.80 -- Entry 16, Pts +6.80, +42% IV 20.4/22.3
    MAR2 1850/1900/1950 Fly @ 9.55 -- Entry 8.60, Pts +0.95, +11% IV 24.4/21.8/19.3
    FEB 1850/1900/1950 Fly @ 18.05 -- Entry 12.60, Pts +5.45, +43% IV 23.9/19/17.4

    The calendar and the ST fly performed about equally however we have two positives with the calendar:
    1) Fewer legs = fewer commission
    2) Opportunity to continue trading position if we didn't get the bounce, the fly will expire in a week. We could roll the short leg of the calendar another 2x theoretically.

    I was afraid with a bounce that the IV drop in the back end of the calendar would hurt the position relative to the fly but at least in this scenario it does not seem to be the case. The IV of the calendar actually held up well when comparing entry and exit IV.
    Rick T and dtheo like this.
  5. N N

    N N Well-Known Member

    Since we nailed the SPX target (I should write a newsletter lol!) here are the following marks:
    FEB/MAR2 1890 @ 26.75 -- Entry 16, Pts +10.75, +67% IV 22.5/24
    MAR2 1850/1900/1950 Fly @ 10.05 -- Entry 8.60, Pts +1.45, +16% IV 25/21.8/18.9
    FEB 1850/1900/1950 Fly @ 28.60 -- Entry 12.60, Pts +16, +78% IV 35.7/22/19.5

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