Post by He Shuhan on Jun 28, 2006 14:22:00 GMT -4
Dear Kareen,
Yes as long as you have enough cash in your account you will be able to to construct the strategy as shared by Chiu. What Chiu meant that one needs to be a relative size player is that, since the short legs have limited the profit potential of a trade, one would need to open larger positions to get a similar benefit as one would have gotten using an outright purchase strategy. Also since the probability of volatility surprises wiping the benefits of the sold leg out is relatively high, one would need to reserve more "debunked" funds for further actions, for example, closing of some long legs to avoid getting caught in an alligator spread.
When Donnie spoke of the statement of non-linear interpolation of time decay, he is actually pointing out any important (but often neglected) issue of options. When measuring the concept of time decay on options, we use the theoretical value of theta to do so. Every option experiences time decay, but the characteristics of an option changes the way this decay occurs. For a start, an ITM option decays like a waterfalll while an OTM option decays like a skwed smiley with the median towards the right side. Secondly, volatility plays a huge impact on the current time decay curve of an option. That is why, the moment the price changes significantly after a position has been established, the carefully planned trade would need continous adjustment to be profitable. A trader, if not tenacious enough in constantly growing and snipping his spread (Spread traders such as George Fontanils and John Summa do that all the time), may have shorted too little or too much options to compensate for the time decay loss - sometimes to the extent of underprotecting his position or over killing by incuring on opportunity costs.
Whilst it may be appealing to trade spreads without precision control in greeks, option spreads remains a demanding vehicles which requires high precision for profitability in the long run. Thus I guess I'd have to say that what Donnie commented has to be factored into the equation when considering such a strategy.
Alas, Chiu's approach to compensating for time decay can actually be a good thing - for backspreads and ratio spreads are known amongst V-traders as the "King of Spreads", and it really works!
Yes as long as you have enough cash in your account you will be able to to construct the strategy as shared by Chiu. What Chiu meant that one needs to be a relative size player is that, since the short legs have limited the profit potential of a trade, one would need to open larger positions to get a similar benefit as one would have gotten using an outright purchase strategy. Also since the probability of volatility surprises wiping the benefits of the sold leg out is relatively high, one would need to reserve more "debunked" funds for further actions, for example, closing of some long legs to avoid getting caught in an alligator spread.
When Donnie spoke of the statement of non-linear interpolation of time decay, he is actually pointing out any important (but often neglected) issue of options. When measuring the concept of time decay on options, we use the theoretical value of theta to do so. Every option experiences time decay, but the characteristics of an option changes the way this decay occurs. For a start, an ITM option decays like a waterfalll while an OTM option decays like a skwed smiley with the median towards the right side. Secondly, volatility plays a huge impact on the current time decay curve of an option. That is why, the moment the price changes significantly after a position has been established, the carefully planned trade would need continous adjustment to be profitable. A trader, if not tenacious enough in constantly growing and snipping his spread (Spread traders such as George Fontanils and John Summa do that all the time), may have shorted too little or too much options to compensate for the time decay loss - sometimes to the extent of underprotecting his position or over killing by incuring on opportunity costs.
Whilst it may be appealing to trade spreads without precision control in greeks, option spreads remains a demanding vehicles which requires high precision for profitability in the long run. Thus I guess I'd have to say that what Donnie commented has to be factored into the equation when considering such a strategy.
Alas, Chiu's approach to compensating for time decay can actually be a good thing - for backspreads and ratio spreads are known amongst V-traders as the "King of Spreads", and it really works!