Wednesday, December 17, 2008

SPX Straddle Case Study Update

I mention very few possible trades on the blog and when I do so it is always for illustrative purposes only. As a consequence, I rarely feel an obligation to follow up on a previous post that identified a possible trade.

Today, however, seems like an opportunity that is too good to overlook because the timing and the math just happened to work out so nicely.

Exactly one week ago, in Is the SPX Going to Stick Close to 900?, I outlined my opinion that I thought there was a strong chance the SPX “would settle in a trading range of 820-980.” I also mentioned the “possibility that the SPX might start to feel some gravitational pull around the 900 mark and start trading in an even narrower range, with the 900 area becoming a No Man’s Land of sorts.”

For those who might have similar thoughts about the market and were looking to harvest some volatility as income, I suggested a menu of strategies that included straddles, strangles, condors, and butterflies.

I chose to illustrate one possible range bound trade with a short straddle using the S&P 500 index (SPX) as the underlying. With the SPX trading at just a shade over 900 at the time, the puts and calls could each be sold for 30.00 per contract. Fast forward one week and the SPX is still hovering around 900. After one week of time decay and a VIX that has fallen approximately 10% during that period, both the puts and calls have had their prices cut in half, from 30.00 to 15.00.

As expiration approaches, options trades move from the realm of investment to crap shot, but it is interesting to see a real life case study in time decay in which all the numbers behave as they normally do only in a textbook.

[source: optionsXpress]


Anonymous said...

It may be interesting to analyze the profit potential for VIX January credit straddles since option sellers benefit from time decay during the holiday season and since volatility often decreases during the holiday season. Your Noember 20th post entitled "Vix at 78.62; Dec 100 calls trade at 1.05" outlines the profit potential for Vix option credit spreads and/or credit straddles since all December VIX options with a strike price above 55.0 expired worthless today.

Damian said...

Great call on this one (so far!) Bill. Wish I'd taken the trade.

Anonymous said...

I love your analysis. Hii. I see today bearish divergence 60 minutes charts. Problem if spx fall below 885.

Nirvanic said...

Not trying to hijack the thread but just wanted to throw this your way.

VIX/SPX non-confirmation today.

I've been watching the VIX closely for about a year and use it as a key indicator. Today there was what I call a VIX/SPX non-confirmation, meaning that both the SPX and VIX were red. One of my main rules is that the VIX and the SPX cannot be the same color. When this happens there is something wrong. If the VIX and the SPX are green, then usually the SPX will go red and the same in reverse.

I have only seen a few days lately where there was a VIX/SPX non-confirmation. They are rare and so I don't have a lot of data on these. In the occurances I have seen, the VIX has been the 'tell.' If this holds true, then tomorrow should be a green day because the VIX was right, not the SPX.

Just throwing this out for discussion. Unfortunately I don't have much time to read message board threads but if this turns out to be something you find interesting or worth tracking, please email me so I'll be sure to stop by occasionally to follow your site.

One more thing, VIX has just had a Bearish Aroon cross. I noticed it yesterday, Tuesday, but it could have happened Monday.

Anonymous said...


I have a hunch those days you notice VIX and SPX are both red are often days when VIX futures expire---like today.

Nirvanic said...


On Tuesday, 11/25, VIX/SPX closed red. Next day, 11/26, there was a nice rally.

Friday, 11/28, VIX/SPX closed green. Monday, 12/1, major down day.

I don't trade options but I don't think these were expiry dates.

Question remains as to whether or not this non-confirmation is of any value at all. I obviously haven't been keeping track of these events long enough to be able to make anything more than a wild guess.

Anonymous said...

Concerning Nirvanic's December 17th 7:14PM posting, the Vix closed down 2.53 to 49.84 on December 17th and the SPX closed down 8.76 to 904.42 on this day. The SPX did not rally on December 18th as it closed 19.14 points lower (-2.1%) to 885.28. The Vix cash index also closed lower on December 18th as it closed down 2.5 points to 47.34 (-5.0%). December 17th & 18th represent consecutive days that both the VIX cash index and the SPX index closed down.

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