Kris Profile picture
16 Apr, 16 tweets, 5 min read
Some general thoughts which keep coming up based on questions I get in DMs about option trades.

Novice traders/learners might find them discouraging but I think in the long-run knowing this now will help you plan your learning more efficiently.
There's 3 large categories of using options. Each has a very different starting point.

Be very aware which category your strategy targets.

1. Options as expressions of directional axes
2. Relative value volatility trading
3. Using vol flows to generate directional alpha
1. Options as expressions of directional axes

If this is your strat, then 95% of the work is upstream of your option implementation.

Your fundamental work may uncover a forecasted distribution that disagrees with the option surface.

cont...
Most DMs fall in this category and don't realize it. Questions like should I sell the 5% put to buy the 10% put or whatever.

I ask "what fundamental work have you done that suggests the surface is wrong?"

More on this here:

moontowermeta.com/structuring-di…
2. Relative value volatility trading

If you are doing this at home, may your god be with you. Correlation trading, IV vs RV, cross-sectional relative value.

My first question is are your IV computations even correct? Do you know how to clean vols for time and events?
How extensive is your dashboard to see what @bennpeifert calls "disturbances in the force"? The data infrastructure for these strategies is expensive. You are trading for edges smaller than a bookie. Is your bankroll appropriately sized?
There is a good reason why most vol traders I know who go out on their own don't do "volatility trading". Instead they focus on more discrete bet types like special sits...@KidDynamiteBlog was epic demonstration...SPAC trading is another
3. Using vol flows to generate directional alpha

This is all the vanna stuff. It's relatively new as the option market "tail wags dog" effect has amplified in the past few years.

This wiki page is devoted to the awesome folks doing and writing about it

notion.so/abdelmessih/Fl…
My own anecdotal experience is flows absolutely matter esp if options are priced too tightly ultimately providing more liquidity than the underlying. I've seen it in commods which is mostly the vol markets I trade.
The work of the people above systematizes the analysis and more accurately measure it than anything I ever did.

My own incorporation of it was understanding who held large chunks of OI and trying to anticipate players' behavior on how they might manage around the greeks...
Large hedging flows occur in oil and ags for example. Understanding their rhythm and triggers is important.

Certain areas of the surface become "infected". Again, I never systematized my analysis, but discretionary vol traders always have a mental framework around this...
But accounts like @nope_its_lily @jam_croissant @SqueezeMetrics and @HauVolatility are being methodical and public about how they do it.

I'd say follow them but 100% of the people following me for options already follow them. Efficient market.
The main takeaway is knowing the source of alpha you are using options to access.

If you ask me about a single stock option trade, I'm just going to ask you about your fundamental research. That's the hard part. If it's done well, the option part is comparatively trivial.
If you have an opinion on the vol, it better not be as naive as "well the realized vol is X or skew is Y".

You are pointing to info any donkey can easily see. Instead, you need a composite view which has seams nobody else can see.
So #1 isn't really about options. #2 is a game very, very few playing from home can play (@darjohn25 and a few in his sphere are people to follow).

For #3, you know who to follow.
Done with the real talk now.

If you think I'm wrong, I'm all ears. I'd be happy to be wrong.

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More from @KrisAbdelmessih

10 Apr
An example of why weekly vol is more volatile

Suppose 5 day option. Stock daily vol is 1% per day.

IV = sqrt(.01² x 5 days x 52 weeks) = 16.1%

Ok say 1 day is now expected to be 3% daily vol

IV = sqrt([.01² x 4 days + .03² x 1 day] x 52 weeks) = 26%

What happened?
The single day expected vol jumping from 1% to 3% means there is more variance in that single day then the remaining 4 days!

.01² x 4 days < .03²

For a longer dated option the increased vol from a single day (like earnings) is clearly diluted...
If the option had 2 weeks to expiry:

IV sqrt([.01² x 9 days + .03² x 1 day] x 52 weeks) = 21.6%

1 month:

IV sqrt([.01² x 21 days + .03² x 1 day] x 12 months) = 19%

So let's recap what happened when we inserted a single day of 3% vol to understand the risk...
Read 5 tweets
10 Apr
Explained to a learner in my DMs who underestimates the vega risk of a near dated option:

It's true that the near term option's vega is not large. But that is counterbalanced by the fact that near term IVs move faster (ie are more volatility then longer term IVs)
A 1 month ATM option has 1/2 the vega of a 4 month option.

But if the 1 month IV is twice as volatile it's the same vega risk.

Need to consider vega and the vol of vol.
(This is a doorway to a whole discussion about term structure and vega scaling but I'm not running down that stuff anytime soon...maybe @AgustinLebron3, @Ksidiii, or @volmagorov can thread one while sitting on a toilet)
Read 4 tweets
2 Apr
When I was a Susq I heard Jeff speak a few times. Always engaging.

They were savage in my days there but the doubling down on tech and brains thru the years probably makes Jeff the richest dude in the world you never heard of (unless you look at pol donations, then you know)
One of the talks was on the primacy of markets (Yass is an extreme libertarian, free-marketer, no fool should be allowed to keep their money type. Appealing views to many traders, esp when they are young)

This post was one of his market lessons.

moontowermeta.com/dinosaur-marke…
I remember when I was a 1st year mm on the Amex and I reported a giant trade that got crossed in AIG on the internal chat.

I got a dm.

"Pls call". It was from Jeff.

I was never so scared. Was I supposed to break that cross up?

Cont...
Read 9 tweets
31 Mar
Intermittent follower farming (not sure what the endgame of this racket is...yet)

My finance ed threads and posts are all organized in "moments"

This is one of them:

⚡️ “Moontower's Market Meta Game Concepts”

twitter.com/i/events/13120…
Here's another of a bit denser material...

twitter.com/i/events/13120…
Here's stuff useful to anyone

twitter.com/i/events/13120…
Read 4 tweets
31 Mar
Random thoughts on hedging an options book.

Delta hedging is a trade-off between transaction costs (direct+slippage) and risk reduction.

When you compute realized volatility you choose a sampling period, say close-to-close.

You can think of your delta hedges as samples.
If you and I delta hedge at different prices we are sampling different volatilities. C-C vol might not even correlate with our samples.

So everyone's lived experience of their attempted "market neutral" is different based on how their sampled vol compared with the implied.
This is why delta hedging is bedeviling.

It is the link between the implied vols you trade at and the subsequent p/l you realize regardless of what some objective measure of realized spits out.
Read 11 tweets
30 Mar
Fish breakfast
Multiple people have reached out for the link to the house...dm if you want. Treehouse, bocce, heated pool, sauna, vineyard, sleeps 5 families, 3 acres.

I agree strongly with all the reviews...pics don't capture the expanse and beauty of the property.

Zestimate feels low
1800/night but sleeps 20
Read 4 tweets

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