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Is 2016 the most challenging year for delta neutral strategies ?

Discussion in 'Options' started by Raj K, Sep 8, 2016.

  1. Raj K

    Raj K Member

    Wanted to know what others think about 2016 in terms of delta neutral strategies. We have some very experienced members here. What are your thoughts ? If it is one of the worst then why ? I am still in learning phase and doing back testing in OV with live trading from last 6 months. All feedback welcomed.
  2. ACS

    ACS Well-Known Member

    I think Friday provides a perfect example of why this year has been tough. It seems like there have been more than the usual amount of abrupt changes from low volatility to high and back which wreak havoc on positions, especially close to expiration.
  3. Kevin Lee

    Kevin Lee Well-Known Member

    Hmm... this is a great question. In my memory, I felt 2008, 2010, 2011 were the toughest for me. Back in 2008 - 2011, daily movements of 2% to 3% were much more common then, that's 40pts to 60pts SPX today. I would consider 2016 an average year. 2013 to 2015 were easy years.

    I was curious what the data says, so I did a quick analysis.

    I looked through SPX 2007 to 2016, comparing daily movement in both % and standard deviation. See below table - showing number of trading days in each year by SD move and % move. Also captures worst up and down days in the year. Excel spreadsheet attached.

    You can form your own opinion.



    Attached Files:

    Philip, RayM, Paul and 5 others like this.
  4. Paul Demers

    Paul Demers Well-Known Member

    Thanks for the great info.
    Kevin Lee likes this.
  5. Raj K

    Raj K Member

    Agree ACS. Thanks Kevin for providing really helpful information !. Always helps to hear from experienced traders. Time to back test all the way to 2007 :)
  6. watersc

    watersc Guest

    i didnt trade yet in 2008 era
    daily move and whipsaws looks scary back then :eek:

    i wonder if the premiums compensated that kind of move?
    maybe we got wider range and cheaper spread relative to low IV environment? o_O
  7. Kevin Lee

    Kevin Lee Well-Known Member

    If you measure the daily movements in standard deviation, that'll take into consideration the IV and hence the premiums paid.
    watersc likes this.
  8. Boomer34

    Boomer34 Well-Known Member

    Great info Kevin!
    Kevin Lee likes this.
  9. ACS

    ACS Well-Known Member

    In my experience it's not the high volatility itself that hurts if the option premiums reflect it and your method is adapted to it. The problem is when there is a sharp transition from low to high or high to low. That is when negative Vega or Delta positions are most vulnerable. This year we have seen several of these transitions and I think that is what has made it a tough year.
    Gabor Maly likes this.
  10. Kevin Lee

    Kevin Lee Well-Known Member

    Fair point about the pain in transition to high vol.... However, if you look at the graph below, this years vol spikes are quite mild compared to 2008, 2010 and 2011.

    Raj K, DavidF, Trader G and 1 other person like this.
  11. DavidF

    DavidF Well-Known Member

    Was there data commercially available to backtest strategies in 2008, 10 & 11?

    This aspect has given me so much more confidence in how various set-ups handle spikes and crushes in volatility, would have crash and burned without it (was almost wiped out last Aug, never backtested, trading too big, expecting a buy the dip Monday etc).
  12. Paul Demers

    Paul Demers Well-Known Member

    I bought data back to 2006 from Livevol.
    DavidF likes this.
  13. jim

    jim Administrator Staff Member

    Kevin, this is a nice piece of work. I also really liked your video on Skew.

    As for the question, is 2016 a different year for market neutral trading?...

    I have been trading options since 1995... for me, SEP and OCT 2008 was the toughest period I ever traded by far. The VIX hit 89.5, and I thought Skew was spelled SKU. I didn't know crap about Skew back then. I didn't realize how brutally punishing IV and Vega could be the Iron Condor or Butterflies. I had also severely underestimated how much Gamma could kick my ass. I am not talking about the Gamma if we move one point. I am talking about the ass kicking I received when the SPX when from over 1250 down to 840 in less than three weeks, and during which time the VIX went from 13 to 89.5. You can back test for the rest of your life, but NOTHING, and I mean no amount of preparation will equip you to deal with that type of market devastation. I was trading a $8,000,000 hedge fund account back then. I still wake up with nightmares about the 2008 crash.

    BTW, thanks a lot for bringing this topic up. I will blame you all tonight when I wake up in a cold sweat because of my nightmares . :eek::eek::eek:

    2008 was much worse than the dot-com bull market or the subsequent bust. Also, September and October of 2011 was a tough trading time for me, but nothing compared to the Fall of 2008.

    As for 2016, I think the thing that has played tricks on options traders is the fact that we have had a LOW IV environment for most of the year. However, we have also had three sudden drops in the markets (in JAN/FEB, on JUN 24 and 27 due to Brexit, and starting on Fri, 9/9). While the recovery (or not) of the current market, is still an unknown, the story for the other to market declines are already in the history books (and the charts). I believe the challenge that befuddled and bewildered most non-institutional option traders was PUT Skew. In JAN/FEB the PUT Skew got very flat (see chart below), hitting a multi-year low. This is normal and should be expected with a market decline with the magnitude that we experienced in JAN and FEB. However, the market decline that Brexit trigger was very different. PUT Skew got steeper, not flatter! (Again, see chart below.) This had HUGE effect on Iron Condors, Butterflies, etc., especially on the strikes below the money.

    I guess that maybe I am just a lot older, a little wiser, and I don't want to shit my pants again like I did in the Fall of 2008. I am hoping that I won't need to wear Depends for Adults for another 40 years. So far,` 2016 has been a very good year for me. At the beginning of 2015, I stopped trading all underlyings except the SPX. I stopped searching for the Holy Grail of trades because it doesn't exist. I stopped watching and reading the financial news and trying to figure out which talking head is smarter than the next. I only look at my Technical Analysis for you guys, the Capital Discussion community. I don't use Technical Analysis in any of my trading. I stopped all the useless crap that I was doing. Since 2015, I trade one thing and one trade only: my SPX Kevlar. This is because, at the end of 2014, I started to solely focused on the only trading edge that I knew still existed (Skew). I altered my Kevlar to have two separate trade entries: one for low IV and steep PUT Skew and other for high IV and flatter PUT Skew. I also spent a lot of time designing, building, modeling and backtesting (and then re-designing, re-building, re-modeling, and re-backtesting) the best risk management techniques that I possibly could. IMHO, the key to any good risk management approach is built around managing your Deltas. The best way to manage your Deltas is to keep Gamma as small as possible compared to the amount of Theta you are collecting. Most of the time the Gamma of my Kevlar trade is a minuscule negative number (under -0.9 on a $50,000 account/trade). Sometimes, I can even get it to be a slightly positive number. Collecting a significant Theta number with a Gamma almost at 0 is a VERY, VERY difficult thing to accomplish in any trade, but it was the most important goal that I had when starting my Kevlar journey. I am happy with my results.

    That is it. That is the big secret. Find a trading edge. Exploit it repeatedly. Focus on risk management.

    So, how happy am I? How has this simple approach worked for me with my trading? Here are the performance results of my Kevlar Butterfly since I started sharing it with the Capital Discussion Subscribers.


    Jim R
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  14. Raj K

    Raj K Member

    Sorry Jim for awakening dragons :rolleyes:. Ouch hearing your story about 2008 is indeed painful.
    Jim thanks for sharing your experience and excellent information including how your approach is with Kevlar and fundamentals behind it and the edge.
    Many of you have gone through the journey I am going through in terms of learning and re-learning and trying to find a strategy that suits ones style , daily commitments and temperament (lack of better words) and in the longer run has positive expectancy. One thing which has really happened positive for me in 2016 is that I joined this wonderful and helpful community. There is wealth of information here that one can learn from . Wish I had come across CD long time back would have saved lot of frustration, money and time. Still learning in detail advanced topics such as skews and how volatility change impacts once you are in a trade for eg low to high.

    Thank again to all of you. Hopefully I can contribute once I have reached that stage.
  15. DGH

    DGH Administrator

    My comments will be very brief. I have been trading options full time since 1994 when I retired from my neuro-pathology and surgical pathology practice. What have I learned? Basically, Jim and I (and, probably many others in the CD community) obviously learned similar lessons: 1. nothing can prepare a trader for a huge downturn, volatility increase, and uncertainty which occurred in 2008...my worst year ever. However, once having experienced a debacle like 2008, the trader is rewarded with a distinct, albeit painful, memory imprinted on his/her brain forever. 2. Regardless of strategy, it is critical to keep deltas and gammas low. No exceptions. 3. Being proactive is paramount if the markets hint that they are going to nose dive. Waiting too long to recognize a developing problem has blown up many accounts. 4. Exiting a "bad" trade with a relatively small loss as opposed to "hanging on" and ultimately taking a big loss is critical.
    onyxperidot, Wes Y, vega4mike and 5 others like this.
  16. Raj K

    Raj K Member

    Thanks Dan for sharing your experience and important points. Agree with many of you here that we need to keep gammas low along with check on deltas. Which brings other question to my mind, but I will first search this forum and make sure it is not answered before.
  17. jim

    jim Administrator Staff Member

    As always, your comments are astute, insightful and helpful based on your knowledge gained over decades of trading... but unlike mine, they're also succinct. :(:cool::rolleyes:
  18. Kevin Lee

    Kevin Lee Well-Known Member

    Jim / Dan, truly words of wisdom. I had the fortune to learn from both of you since I started trading. You have helped me tremendously. Thank you.

    Among what you said, what I found most useful and they are my guiding principles as well :

    1. Keep delta and gamma low - No exceptions. Perfectly okay to take a lower return if necessary.
    2. Ignore noises - unless something can be proven by facts and back testing to offer competitive advantage, it is noise. That to me includes technical analysis, CNBC, Fed speeches etc..
    3. Stop searching for holy grail - focus on doing one or two trades exceptionally well than knowing two dozen trades superficially
    Last edited: Sep 14, 2016
    Chuck, Raj K, Wes Y and 3 others like this.
  19. Paul

    Paul Member

    Kevin, Dan, and Jim:
    Your contributions to the Capital Discussions community in general, and to this forum thread in particular, have been hugely valuable to me. I have "cut and pasted" your comments above into an Evernote "note" and I plan to read it every morning to achieve a proper mind set! Thank you! :)
  20. Steve S

    Steve S Well-Known Member

    I just recently finished a project loading and scrubbing Livevol 1-minute SPX data from 2004 to 2016 ... the basic market data was fairly clean and checked out against a database I used extensively in 2014, but the implied vols and greeks were all over the map ... some samples were just out-of-this-universe total garbage while others were located on planet earth but still had poor quality rates and forwards that gave poor-quality greeks that I would urge anyone to NOT use. It's easy enough to do your own vols and greeks for most people in this community, but if you want to try theirs then do some extensive sampling before using! I have a spreadsheet set up for reverse-engineering Livevol raw data to check out their inputs if anyone is interested.

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