Trading Insights and Strategies
Gain valuable insights into successful trading strategies, risk control, and the importance of expected value. Explore concepts such as edge, mathematical hope, and trading the index implied skew, along with tips on monetizing the premium and understanding quoting conventions. Discover empirical results on SPY options trading for practical application.
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Presentation Transcript
Disclaimer Opinions are all mine and are not those of Hull Tactical. No recommendations are made or implied. Trading is inherently risky and may lead to losses. Past performance is no indication of future success. 1
Tradings Holy Trinity Successful trading requires: A strategy with positive expected value. 1. Risk control. 2. The psychological make-up to stick to the first two pieces. 3. Expected value is by far the most important, and the hardest thing to find. 2
Edge, Expected Value, Mathematical Hope The least likely way to find EV is through knowledge . Your ideas need to be correct and different. You are very unlikely to have macro ideas that are unique enough to profit. For example, your ideas on Fed policy are not a good basis for trading. If you think you have found a situation where all the insiders are idiots, it is because you don t understand the situation. 3
Edge, Expected Value, Mathematical Hope Edges will be either: Inefficiencies. 1. Risk premia. 2. Risk premia include: Equity premium. 1. Value, size, beta, quality. 2. Variance premium. 3. 4
Trading the Index Implied Skew The implied volatility skew creates a skew premium that can be monetized. The skew premium is similar in kind to the variance premium: it is a risk premium that can be mispriced. But the skew premium is a separate phenomenon that adds alpha and diversification to an equity portfolio. 5
Monetizing the Premium But there is a simple, approximate relationship between risk- reversals and the implied skewness (Carr and Wu, 2005). 4.45 ?25????????? ?25???????? ???? ?3 This assumes slope of the implied curve dominates the curvature (which has become less true over time). Only a good approximation close to ATM. But the important conclusion is that the risk-reversal is priced in skew terms. 6
Quoting Conventions Statistical skew of the index is negative. Slope of the implied volatility curve is negative. But traders often quote it as positive 7
Empirical Results: SPY Sell one 2-month, 25-delta risk-reversal on SPY (sell put, buy call) based on Reg T margin requirements. Delta hedge by selling 50 shares short. Adjust strikes weekly. Cover with 2 weeks remaining. 8
Empirical Results: SPY Hedged Risk-Reversal 200 180 Account Value 160 140 120 100 80 Date 9
Empirical Results: SPY Statistic Hedged Risk-Reversal CAGR 6.43% Volatility 4.94% Skewness 0.13 Excess Kurtosis 10.17 Sharpe Ratio 1.18 Maximum Drawdown 5.04% 10
Empirical Results: SPY Statistic 10-Delta 15-Delta 20-Delta 25-Delta 30-Delta CAGR 3.18% 4.55% 5.92% 6.43% 6.51% Volatility 3.81% 4.46% 4.80% 4.94% 4.93% Skewness -0.84 -0.47 -0.06 0.13 0.58 Excess Kurtosis 25.29 20.53 13.39 10.17 7.43 Sharpe Ratio 0.68 0.89 1.11 1.18 1.20 Maximum Drawdown 6.03% 6.45% 4.55% 5.04% 4.34% 11
Relationship to Variance Premium Short Straddle 530 480 430 Account Value 380 330 280 230 180 130 80 Date 12
Conclusion The short risk-reversal has a statistical edge. It is independent of the variance premium. Both can be added to enhance equity portfolios. 13
