Aug 23 – Less Talk more Rock

Less nuanced talk…

After reading my previous posts, I realised just how nuanced the language is and how it’d be only relevant to a few people which got me thinking that it’d be interesting to try to explain all of this in terms non-complex options traders could understand. I mostly write this blog for myself as a record of my thoughts, plans and actions as well as for entertainment and perspective differences for all the crew in the mastermind group.  

I guess I’ll start with where these ideas came from and what the style of trading is.


We’re a group of people that came together with vastly different backgrounds and strengths. It all sorta started when Emeric and I formed a Rhino trading Skype group back in 2015 that ended up attracting hundreds of people, including Ron Bertino (the founder of PMTT). That ran for a few years and Ron ended up taking over the admin portion of the Skype group (I can barely keep up with a travel/trading blog let alone managing and admin’ing a large Skype group) and eventually we all moved over to slack via the newly established PMTT group. Most of us have been working together for the last 4 years trying to explore and tackle the dart arts of “out of the money” complex options trading.  We are a vastly diversified experienced group that includes quants, some professors, some fund managers, some managing 10s of millions of their own money and others are straight up small retail traders and even others that barely trade (Delayvis) and are mostly in it for the intellectual challenges. The area that we are dabbling in was quite unexplored and very nuanced. We’ve had our ups and downs and certainly had our egos kept in check with a lot of explorative strategies that went sideways after much research. Why? I explain below.


Many of our models fail or ideas failed and the current modelling software available still hasn’t done a great job of predicting risk curves and market responses. We try to remove or mitigate most of those risks (Out of the money options risks) as well as modelling differences in an effort to capitalise on this alpha (the additional return). The alpha mainly comes from the premium in the markets (the need for insurance from big portfolios etc) as well as being one of very few groups likely exploring the areas we are exploring.  When we started in 2015/2016, we only had end of day data for options from 2008/2009 and on and really the only testable data was 2011+ with incremental hourly data.  This means that things we’d test really had very limited data sets and when you got into super complex positions though they’d test well and the modelling software would show reasonable profiles, they’d eventually get busted up in live trading. This constant evolution coupled with the fact there are very bright minds in the group has bolstered the testing, strategies and executions to where we are now. It’s eliminated a lot of types of trading and eliminated a lot of the unknowns that we experienced previously. Out of the money options trading really is a dark art like I mentioned at the beginning. We do have a lot more data now in tumultuous periods like (Feb 2018, Oct 2018, Dec 2018, May 2019 and Aug 2019).

So what are we really doing at the very basic level?

We’re insurance salesmen who also insure ourselves. That’s it.


Options can be thought of as insurance. A person can buy insurance at any level in the market (known as the strike). Someone might say I only wanna lose 2% max in their portfolio and they can purchase insurance 2% below the money. Another might be comfortable with a strike 10% below the market and they can purchase insurance 10% below the market and so on. If the market is at 2900, you can buy insurance at 2895, 2890, 2875 and so on.  The prices of insurance vary at each strike. Now as we all know, insurance prices in any industry has some fixed things in the pricing and a pricing related to risk (is it likely a hurricane is coming, pricing goes up!) this is the same as “fear” when related to market insurance.  As you can imagine, each price of each level of the market can vary in how it responds to an event in the market. The 10% below market has a “fear” portion as does the 2% strike and this amount can vary for each strike based on market pressures not only at the time you put it on but how it reacts to any event.  This is kinda known as skew.  It’s pretty much unpredictable in any real sense except when it gets stretched or abnormal you can expect a reversion to mean eventually.  Also, every insurance contract has an expiration date. The closer it gets to that, the less value an insurance contract has until the risk portion of the premium gets to zero at expiration. That’s our theta (or the average amount the contract will lose every day (we gain) with all other things remaining the same).  So we sell insurance for a premium but we also buy insurance in this complex setup of contracts that creates a risk profile graph. All of the positions we enter will generally have a positive theta (a time based deterioration of value that benefits us). For instance, my current portfolio has a theta of 11.5k a day. Which is on the high side but that’s because we just came out of a high volatility period where the premiums got jacked up and now we get the benefit of it having to come out before the contracts expiration date. I can expect to gain that over time and on average every day but if we have a super negative tweet from Trump about the trade deal, I can expect to take a hit on my account because my trade also has what’s called negative vega. Which is it responds negatively to volatility. Generally, a positive theta trade has negative vega. My negative vega is currently 100k!  If the volatility in my options go up 1 point, I can expect to take a temporary draw down of 100k. This is the price we pay as risk brokers. But! as you can imagine, as time goes forward, there’s less and less days in the contract and less and less vega can affect it. Vega acts on the time portion of the insurance contract. That’s not considering weighted vega effects re OTM but that’s for another day. Just speaking in generalities.


Options can be thought of as insurance. A person can buy insurance at any level in the market (known as the strike). Someone might say I only wanna lose 2% max in their portfolio and they can purchase insurance 2% below the money. Another might be comfortable with a strike 10% below the market and they can purchase insurance 10% below the market and so on.  The prices of insurance vary. Now as we all know, insurance prices in any industry has some fixed things in the pricing and a pricing related to risk (is it likely a hurricane is coming, pricing goes up!) this is the same as “fear” when related to market insurance.  As you can imagine, each price of each level of the market can vary in how it responds to an event in the market. The 10% below market has a “fear” portion as does the 2% strike and this amount can vary for each strike based on market pressures not only at the time you put it on but how it reacts to any event.  This is kinda known as skew.  It’s pretty much unpredictable in any real sense except when it gets stretched or abnormal you can expect a reversion to mean eventually.  Also, every insurance contract has an expiration date. The closer it gets to that, the less value an insurance contract has until the risk portion of the premium gets to zero at expiration. That’s our theta (or the average amount the contract will lose every day (we gain) with all other things remaining the same).  So we sell insurance for a premium but we also buy insurance in this complex setup of contracts that creates a risk profile graph. All of the positions we enter will generally have a positive theta (a time based deterioration of value that benefits us). For instance, my current portfolio has a theta of 11.5k a day. Which is on the high side but that’s because we just came out of a high volatility period where the premiums got jacked up and now we get the benefit of it having to come out before the contracts expiration date. I can expect to gain that over time and on average every day but if we have a super negative tweet from Trump about the trade deal, I can expect to take a hit on my account because my trade also has what’s called negative vega. Which is it responds negatively to volatility. Generally, a positive theta trade has negative vega. My negative vega is currently 100k!  If the volatility in my options go up 1 point, I can expect to take a temporary draw down of 100k. This is the price we pay as risk brokers. But! as you can imagine, as time goes forward, there’s less and less days in the contract and less and less vega can affect it. Vega acts on the time portion of the insurance contract. 


Let’s give an example, lets say I sold insurance for hurricanes pre hurricane season for 5k and it expires in 4 months.  I take on all the risk of hurricanes and I get 5k to do so. If I wanted to offload my insurance contract to a re-insurance group. What would I sell it for?  Well if I had 3 months left, I’d probably say hey I’ll sell it for 4k (pocketing 1k) because there’s 1 month less risk. What if there was 2 weeks left? Well, shit, I took most of the risk and there’s like only 2 weeks left, I’d sell it for say 500 pocketing the 4500. That’s theta in a nut shell. BUT we gotta figure out what Vega is! Let’s say there’s 2 weeks left but news just came out, there’s a hurricane barreling down towards us. its a 15% that it’ll hit, what do I sell it for there? Well there’s 2 weeks, we got a 15% chance, so it’s definitely higher than the 500. That’s vega.  What if it was 50/50? Vega would act on the 2 weeks even more. But as time ticks, every day the vega effect is less and less.  What if we had 3 months left and we got a report that it’ll be a very active hurricane season?  Well, that would probably put me in a loss position for the insurance I sold 1 month earlier.. but only temporarily. Vega and Theta are interlinked. 


It’s kinda a fun game.  For instance, lemme go through what just happened to my portfolio in August..


I was pretty much entering in low vol which really wasn’t what I wanted to do but I wanted to keep the theta coming in, and I wasn’t yet convinced about exploitative STT trade entries. I understood any transition to higher volatility would bring on draw downs (though usually temporary).  I sold insurance when no hurricane was on the horizon, just trying to get the basic premium present in a non fear market. However, I was only like 40% invested. I saved the other 60% for higher vol entries (opportunistic).  Then came the first move from 3020 down to the mid 2900s. I slammed on some since it was the biggest down move we had since like May. Then I fist pumped slammed even more on when we touched 2920/2930 area (the forecast was suggesting hurricanes were kinda possible). VIX was still relatively low, but off the lowest of the lows. That means that the insurance premiums I got were meh but OK.  Probably VIX (vol index) 16.  Then came the down move of the first weeks in Aug. Skew/VIX acted a bit weird (An expectation of that a hurricane was coming). The insurance I sold went up a lot in value (a draw down) but my black swan insurance barely activated (the hurricane didn’t arrive to activate the swan insurance but the fear was maxed out) thus I had a temporary draw down of about 7-8%. Now, usually on moves like this, the BS insurance activates a bit more. My expectation is that any further large down move it’d kick in and we’d start going towards even…but I am concerned (as mentioned in my last post) about how the volatility regime has changed and wondered if there is a path where the STT can continue down in PL and BS doesn’t activate.  In either case, it’d be fine just a bit stressful. If it continued down and BS didn’t activate, I’d roll the structures, I’d probably have a max draw down of about 10%. The new STT would be extremely juicy and extremely resilient being very very very far below the market which is a great thing but we wouldn’t b feeling so great here being down 10% on the roll. As vol subsided and time moved on, I’d eventually get profit out of it and of course correct the draw down. No-one likes a draw down and it feels like crap so it’s not like its ideal. The more ideal situation is that of the older vol regimen where we’d have spikes down and large VIX reactions that put as at break even and we just roll and work the market. If the market continued down even after the roll, we’d have not that much trouble even towards 25% from peak (very rare), I’d likely have to roll again and surely at this point the BS would have activated at some point.  It’d take a few months but we’d recover but mark-to-market would have some swings. 


So anyways, OK, not the nicest feeling but I was up about 30% for the year so it’s not terrible and this is the fun part since we can make most of our profits from rebounds on these types of falls as the majority of our premium and potential is closer to the insurance tent in the risk profile. Then I can convert it into a hedge and wait for more vol spikes


So now at this point, I realise that any pause or stoppage in the fear will bring a quick rebound in P/L and every week of market indecision (and no further crash) is closer and closer to expiration and less and the less Vega can affect (and the more theta converts to my profit). But I also realise that I have to start looking at heavy rolling and risk management because the vega and negative delta is getting steep. So on the first rebound, I add bearish STT (a mid way hedge) and I roll my closest STT as well as short ES.  All of this is a cost but on some down moves, I start selling PCS to convert part of the bearish STT. All of this is a cost…but its largely offset by the fact that we’re in a juicy area of the original trade if we get some vol relief.
One week later I was down about 4% from a draw down in the fear spikes of 7-8% and then just days after that I was profitable on the Wednesday( fed meeting). IE my entire portfolio trade was up about 65k from Aug 1 which is great given the events that transpired. I’ve got a load of hedges still on that compliment the risk profile. The risk profile I posted includes all hedges (Except the Black swan hedge).  Now yesterday was a slightly different story. We had a change in skew (the volatility portions of each strike changed) and I had a draw down to about -7k on the trade but does it worry me? NOT AT ALL. It’s a reaction to the fact that we have an important event on Friday (one being Powell speaking at 10am) and the fact that we didn’t have continuation in the up move. Skew and vol reactions w/ out market moves are generally temporary in relation to the specific structures I trade.  So an area where I sold the insurance either went up or the area I bought went down. Pretty much it. But its all temporary.  If we move up today, we get weekend theta and moving into next week is 4-5 more days of theta and less ability for vega and skew to affect. I predict I am back at the highs pending no big move by end of day today, I’ll post my graph either way to see.


Either way, now its a fun time of having the clock tick and getting further and further into our trade letting it mature. By sep 9 ish, my trade will have a matured risk profile that doesn’t mind more larger falls and starts to become more and more of a hedge profile as I massage out risk and take profits. My aim is to get it to about 250k before I go away. That’s sick. Yes, these trades mature every day and become not only more and more resilient but they also get massaged into hedges for newer trades that have a lot more time left.


Here’s the thing I realised, I tested just entering these trades on massive fear spikes (IE selling when the hurricane is barreling down). This happens a few times a year (probably 4-6x with Trump) and it eliminates most of the risk and has the same return as if you entered monthly (always on). You can do 15%-20% on capital and if you get a few a year, that’s 30%-40% with much less risk, draw down, stress, management and time in market. 

So yeah, It’s a risk game where we syphon out the premiums on insurance.


The most common setup we use is known as a broken wing butterfly. Which is defined +1/-2/+1

2 thoughts on “Aug 23 – Less Talk more Rock”

  1. Good morning Patric.
    It is the first time that I comment and first of all I thank you for sharing all your knowledge and experiences in options. I follow your blog almost since you started it and I look forward to each new post.
    I see that you currently use the BWB version of the STT, but the example you have given +1 (X) / -2 (Y) / + 1 (Z), is it correct? This would be a BWB without bearish risk, instead of being without bullish risk, right?
    Thanks in advance for your response.

    1. I had to remove the strikes due to it being exposing of the trade IP. Sorry about that. I had just made them up as I went but it did actually represent in theory a possible trade.

      Generally, you setup an OTM BWB and purchase BSH insurance. You can follow all this at PMTT course/group. We’ve made quite some changes from the original setup.

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