Monday, September 26, 2011

Trade Idea - Sell short dated options - Why?

Trade Idea - Sell short dated options - Why?

It has become increasing apparent the vol market is positioned the same way as the fed, they have sold long dated vol and bought short dated options - i.e. long gamma, short vega.  This also helps explain why the long end has been so stubborn in coming down, the street is short to clients or via correlation/dispersion books and are patiently waiting to cover with no luck.

On Friday, we noticed a very interesting observation in the market, “market up, vol up”, this typically means that traders want to have either a flat gamma or long gamma book to catch a catalyst or defend a short vega position.  This in turn will have overwhelmed market makers and they kept short dated vol high in spite of the market calming down and moving higher.  This tide will turn quickly with in two states

1. Somewhat calm markets (small rally)
2. Positive News on the margin

As soon as the decay (theta) in the books of option traders starts to overwhelm the position with no lowering of the vol in the long end to help, the front end of the vol curve will quickly get sold as the bleeding of options becomes unmanageable.  The curve will steepen fast.


No comments:

Post a Comment