Playing the Short Side on SPX

After doing a lot of reading and personal research, I’ve reaffirmed that the 1-3 day unit sales were not a good idea: as Taleb would say, I was short concavity for most of my trades. Although there’s nothing wrong with selling index puts to collect the volatility premium, as this is a well-documented and academically researched avenue of portfolio return, it is prone to blow-up if left unprotected. It is a far better strategy to sell index put-spreads instead of just naked index puts at the near term given that you have an established maximum loss, although you should be active in your management to never allow it to reach that level. As well, the Vega is much lower when comparing a single ATM put to five 10 delta put-spreads, although the theta is also lower; but in my opinion, that’s a worthwhile trade-off.

The recent correction from October 10th, 2018 to October 12th, 2018 where the SPX fell below it’s 200 day moving average was a prime time to trade SPX puts. It is counter-intuitive, however, the ideal environment to long puts is during high volatility regimes while short SPX put spreads are ideal during low volatility regimes. In addition, long calls are terrible idea during high volatility environments as they are very sensitive to vega. A quick overview of a decent long SPX put strategy would be:

During a large VIX spike/decline in SPX, purchase far OTM puts (1 to 15 delta puts) on the open of the day with an expiry of less than 2 weeks.
- Set a stop loss for 30% of the cost basis.
- Capture profits at around 200% to 300% of the cost basis.
- Ensure to close the position before 3 pm of the market close.
- Do not over-trade; a single position will suffice. Consider doing 3:1 back ratios of 15:30 deltas.
Do not try and time the market and guess when a drop will occur, it is still very profitable to trade SPX puts during market downturns.
It is absolutely crucial to take profits when playing long options as these are very different from holding stock. The fact that you are holding OTM options means that the contract has a high potential to go to zero since you are trading completely on the extrinsic value of the options.
Short term, far OTM puts are ideal for capturing vega and gamma spikes.

To confirm the above strategy, I have taken a look at the intraday SPX options data for October 10th to 12th as well as the 2.05% drawdown experienced in August of this year.

August 9th, 2018 to August 15th, 2018

The following chart shows the SPX and VIX moves in mid August, 2018 at 5 minute intervals. We see that VIX was steadily climbing while SPX was falling throughout the period.

Taking a look at the SPX options, we note that the 3 to 30 delta puts move sharply upward during the day before collapsing near the close.

The near-the-money calls get hammered the worst and hardly recover during rallies.

A summary of the greeks for the options shown above are as follows:

October 10th, 2018 to October 12th, 2018

The following chart shows the SPX and VIX moves in early October, 2018 at 5 minute intervals. We see that VIX rose sharply while SPX fell sharply throughout the period.

Taking a look at the SPX options, we note that the 1 to 5 delta puts move sharply upward during the day before collapsing near the close. In addition, the 2700 Strike Put opened on October 10th at around 6 delta but reached 40 delta by 2 pm on October 11th. Other far OTM options picked up deltas very rapidly throughout the day, but then sharply declined before the close.

We see that although most of these puts gained value quickly, they also lost value just as quickly near the end of the trading day, even when the market was still incredibly volatile. This is most likely due to repricing the IV at the end of the day to account for the non-trading hours.

Next, note that all calls, whether ATM or far OTM suffered terribly due to IV being left skewed. Note that even after the large 1.5% jump on October 12th, most of the calls hardly recovered from worthlessness.