Thursday, September 3, 2009

SPX Short Straddle Still Hugging 1000 Level

In many respects the ultimate pure play on declining volatility is a short straddle in which near the money puts and calls are sold simultaneously in hopes that the underlying will move very little prior to expiration. While this is largely a neutral directional bet, it is also a bet on declining volatility.

Two weeks ago today, in The Sideways Play, I outlined some of the logic and details behind what a short straddle trade would look like with the SPX at 1004. Two weeks later, with the SPX down a little more than five points, this trade is a winner. This trade is profiting from time decay (theta), which is currently at -1.20, meaning that all else being equal (i.e., if price, implied volatility and interest rates do not change), the position will gain $120 per day.

Of course, the other variables that affect the price of an option are in motion as well. Options traders use options Greeks to measure an option’s sensitivity to various influences on the value of that option, including the price of the underlying, the volatility of the underlying, time and interest rates.

Specific to the SPX short straddle, the increase in implied volatility (VIX) over the course of the past few days has worked against the options position. The Greek which measures an option’s sensitivity to changes in implied volatility is vega (not a Greek letter, but one that is counted as a ‘Greek’ according to options tradition), which estimates the change in value of an option that would result from a 1% change in the implied volatility of the underlying. In the two weeks, the VIX has increased 2.30 points and as the SPX straddle currently has a vega of 1.61, this means that the 2.30 point rise in the VIX has cost the position approximately $370 during the ten trading days.

While there are other factors at work on this short straddle trade, so far the main plot line has been a story of theta vs. vega, with time decay winning out.

The graphic below shows that a position which originally yielded $5000 in premium can now be bought back for $3510, which would lock in a profit of $1490. With the options expiring two weeks from tomorrow and time decay beginning to accelerate as we approach expiration, it will be interesting to see how this short straddle plays out.

For some related posts, try:

[graphic: optionsXpress]


In Debt We Trust said...

I am considering a long straddle on gold. Any thoughts?

Patrick said...

I think gold could go well up to 1080, maybe 1120, and then crash, or it could sail on into history. All the people buying gold are either buying the "this could be it" notion or are trying to sell to those who are inclined to buy that notion, the main X factor is what the vested interests holding billions of oz. in open short positions above 1000 will do. Selling October GLD 110 calls and Oct GLD 90 puts might work. I´d rather buy with a tighter delta.

In Debt We Trust said...

actually, gold's move is entirely seasonal:



The only reason I considered a straddle is that I am unsure how, as Patrick said, gold will react to all the shorts out there.

Anonymous said...

selling condors and Butterflies has worked really well in the declining volatility market over the last 6 months. I like the SPX 1000 straddle. I'm wondering though, how did you get your OptionsXpress trade calcualtor to display this trade with a 30k options requirement? When I set up the same trade, it shows a 200k requirement - because it is two naked short options?

_N said...

if you are trying to play on vol, you should go for butterflies and not straddles

Bill Luby said...

This post and some of the comments here will definitely trigger at least one more post on the subject of the straddle.

Regarding gold, I generally do not trade the commodity or the ETF. That being said, I think I would be more likely to fade the recent price spike with a directional bet by selling calls or a call spread than making a volatility bet. Keep in mind that unlike stocks, for gold the relationship between price and volatility is more likely to be positively correlated than negatively correlated.

Regarding optionsXpress and their margin requirements, I have no idea why my display would be different than yours.

Regarding straddles vs. butterflies, the prior post I link to on the bottom makes the case for butterflies as a more conservative approach. If you are the type that does not sleep well with risky positions open, straddles are not for you, but butterflies may make sense.



EyeDoc said...


Do you have stops set somewhere?

Bill Luby said...

Regarding stops, I prefer to use price levels in the underlying (rather than the position itself) that trigger an exit in the options position.

With the SPX moving up, my biggest concern is an upside breakout. With the highest close of the year a little over 1030, I would consider a close of 1032 or higher to warrant an exiting of the calls.

Should the SPX start moving sharply lower, I would exit the puts with a close under about 975.

The above two price levels reflect the extremes in support and resistance over the last 5-6 weeks or so.

With each passing day, time decay accelerates and helps anyone short the straddle, but the position also becomes more sensitive to changes in the price of the underlying (gamma). Translation: profits can disappear at a faster rate as we get closer to expiration.

As I type this, the change in price of the underlying is almost perfectly offset by time decay, so there has been essentially no change in the value of the position since the last post, even though the SPX has move up to a current level of 1021.



EyeDoc said...

Thanks, Bill

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