Four things to understand before adding risk via options:
1. Understand the Cause of Volatility in your instrument
2. What is ATM Implied Volatility
3. What is the Curvature of the Skew (how pricy are calls and puts)
4. What is the current Term Structure
-- OptionPit
"Everyone knows" that US residential real estate is a bad investment, with the Case Shiller Home Price Index having dropped by about 32 per cent since its 2005 peak. At the end of last week, the iPath S&P 500 Vix Short Term Futures Exchange Traded Note had lost that much in one month. Not seven years. One month. Over the previous six months, the vehicle had lost more than 69 per cent of its value. The managers didn't do anything other than rigorously follow their charter, and their strategy has been fully disclosed, along with the trading history.
The reaction of some investors to this record is interesting: they have been doubling down. There has been a spurt of option buying on the ProShares Ultra Vix Short Term Futures Fund, which aims for twice the daily return for the Short Term Vix Futures Index.
Vix futures or options, you are not actually buying "volatility". Those products are based on the prices of forward start variance swaps. If you don't know what that means, don't buy Vix products.
The higher the risk/reward ratio you have on your trades, the fewer times you have to be right, and still make money. The total amount you are willing to risk per trade is expressed as 1R. If you only take trades that have a 1:3 risk/reward ratio, and you are correct just 50% of the time, you will have a 10R profit on ten trades.
Understanding how to use risk/return and position sizing allows you to make sure you are never over extended on a trade and allows you to always return to fight another day.
VelocityShares Inverse VIX ETN (XIV)
This ETN offers daily inverse exposure to an index comprised of investments in short-term VIX futures contracts-a strategy that has struggled mightily in 2011 thanks to heightened volatility and backwardated markets. Though XIV has lost more than 40% of its value in 2011, there is reason to be optimistic that at least the beginning of 2012 will be more favorable. The VIX, a measure of expected equity market volatility, has declined considerably in recent weeks as optimism over the global economy has returned. And more importantly for XIV, contango in VIX futures markets has also returned; the futures curve now has a steep upward slope, a condition that can give a nice boost to the strategy employed by XIV [see also Low Volatility ETFs Attracting Big Inflows].
Given that XIV utilizes a futures-based strategy to deliver inverse exposure, this ETN probably isn't appropriate for risk-averse investors who aren't willing or able to regularly monitor their positions. But for those who grasp the complexities associated with XIV, the current environment might just be perfect for this ETN. XIV might not be a good ETN to own throughout 2012, but it certainly seems to be positioned nicely for a strong start to the year.
Dispersion trades are a way of betting on an end to the historically high market correlation that began during 2008, when shares of companies in various industries all rose and fell together, frustrating money managers who earned their keep by researching and picking individual companies.
In a dispersion trade, managers sell put and call options on an index such as the S&P 100 during market declines, when demand is heavy among investors who want to protect themselves from losses. They use the rich premiums received for the index options to buy put and call options on some or all of the stocks comprising the index.
SocGen has one take on this idea called Symphony - which is short correlation, long vega. Och Ziff seems to have bitten hard on this idea. It seems to add up as improvements in liquidity make the premise of the trade more compelling.
One of the reasons so many traders get killed in this business is their inability to sit on their hands. Deep inside they crave the action. When the markets are not conducive to trading aggressively or do not warrant having more than average exposure you absolutely have to respect that and stay on the sidelines. If you trade although your trading skills do not match the current trading environment, or put another way, if you have no edge in a certain market environment or your strength requires specific set-ups that aren't there, odds are not in your favour. If odds are not in your favour the smart thing to do is to wait for these external factors to set up again.
Time to review the investing blogroll, 2010.
24/7 Wall St.
A Dash of Insight /Jeff Miller
Abnormal Returns
Barron's
Berkshire Hathaway Annual Letters
Bloomberg
Briefing.com
CNBC
Crossing Wall Street
DealBreaker
Drudge
Footnoted
HedgeFolios
Information Arbitrage
Jeff Saut
Muniwiseguy
ProQuest
Random Roger
Reuters
Sonders
Take A Report
The Big Picture
The Kirk Report / Charles E. Kirk / 12 steps to GTD
TheStreet.com
Trader Mike
TraderFeed
WallStCheatSheet
Wall Street Window
Wikinvest
World Beta
For decades an order to buy or sell a security went to a person in a trader's jacket standing on the floor of an exchange, often at the NYSE in Lower Manhattan. If you wanted to sell stock in General Electric, for instance, these so-called specialists would find a buyer. If they couldn't find one, they bought it themselves.
In exchange for their services, the specialists pocketed some of the difference between the price at which you were willing to buy and the price at which a GE holder was willing to sell.
This system came under attack in the early 1980s from Nasdaq, a rival marketplace for stocks, which began using computers to make trades. The pitch was it could match buyers and sellers faster than humans, and for less money.
Then, starting in the late '90s, the NYSE specialists got hit again, this time with a series of blows: new rules encouraging computer matching of buyers and sellers, a shift to quote stock prices in minute increments of decimals instead of fractions, and a decision to cut the minimum spread that specialists or other middlemen could grab for themselves from 6.25 cents per share to a penny.
''It used to be an oligopoly, an old boy's club,'' said Irene Aldridge, head of an HFT shop called Able Alpha Trading and author of ''High-Frequency Trading.'' ''But now it's a completely level field.''
Critics of high-frequency trading say all this talk about narrowing spreads for ordinary investors distracts from a key problem: Split-second trading without human supervision is a recipe for disaster
Continue reading "High Frequency Traders (HFT) Driven by Spread Squeeze" »
I survived the crash of 2:45pm t-shirts, $20, memorializes on day's trading position.