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First, apologies for taking so long to post this, been away, liked the thread and would like to contribute.
What follows below are my simple rules for making money trading an options VOLATILITY curve.
They are not complete, but this is the essence of the business. If this is all you learn and apply SENSIBLY, you will make money.
Two important considerations are that these rules apply to a nett long volatility curve (hence positive gamma) and resultantly huge losses can result if the market does not move (negative theta from long vol position)
For those who don't know me (I am fairly new to this list): I trade an OTC options vol curve (amongst other things) for a large (by our emerging market standards) proprietary trading company.
Thanks for taking the time to read this, hope you get some benefit. Glad to answer any questions.
Cheers
Zaheer
Making Money trading Options
Areas where profits and losses are made
1. Earning the edge
2. Trading the gamma
3. Taking a view on volatility
4. Taking a view on Interest rates
5. Paying or Earning Theta
Rationale for trading
Gamma Trades
1. Positive gamma is your friend, use it to make money.
2. Gamma trades must be used to pay for negative cash flows when paying theta.
3. Set appropriate targets (to the size of the gamma and the range of the market) to buy and sell, use these diligently.
4. Set appropriate stop losses, execute these immediately.
Short term trades (2 days to 1 week)
1. Earn the edge on all short term trades!!!!
2. Enter in to these to exploit market inefficiencies with respect to volatility.
3. Use these to manage short term theta (and hence gamma) positions.
4. Largest relative Theta exposure arises here, manage it according to your view on "Intraday market volatility" - This is the volatility you are exposed to as a "Gamma" trader (ultimately what all curve traders do)
Medium term trades (1 week to near expiry)
1. Manage Volatility (vega and gamma) and Rho views here.
2. Pay edge only to fundamentally change the position of the book.
3. Edge may need to be sacrificed in order to position the book appropriate to the view. Sacrificing edge does not mean paying it.
Long term trades (Far expiry)
1. This is where the least theta arises, manage it appropriate to long term views of all variables. (bear in mind the absolute size of the position you are amanging vs. the speed with which it changes)
2. Vega to theta ratio is highest here, greatest potential for Vega view profit or loss. (ditto for RHO)
3. Balance the potential profit or loss potential from vega against the potential of profit or loss from theta exposures.
Remember all of these points all the time and apply them to EVERY TRADE.
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