So long as we’ve dredged up a little Cramer, how about we at least have a takeaway from it.

Allen was kind of enough to post this Howard Simons response to the “Great Ultra Market Knockdown” discussion over on Real Money.

Variance Swaps and ‘They’
6/22/2009 4:03 PM EDT

Charles, recall how when W.C. Fields was asked by the rube, “Is this a game of chance?” he was told, “Not the way I play it.”

One of the bigger contributors to end-of-day extensions is position-squaring by market makers in variance swaps. Variance moves as the square of volatility, so on such a day as this when the VIX is up about 10.7%, these market makers have to sell ever-greater quantities of stock at ever-lower prices to hedge. This process works in reverse, too, and I believe much of the kick higher after March 10, 2009, was attributable to the unwinding of such hedges.

But you have to get with the program. Buyers are not “they.” Sellers are “they.” And that extends to the various leveraged ETFs, too: Leveraged-down is bad, and leveraged up is, well, not so bad.

Now I can’t verify his numbers are correct, but the principle is spot on. Consider “they” as anyone effectively short market volatility in some fashion. Be it variance swaps, SPX straddles, whatever. And yes, even Ultra ETF’s. A third party that creates them for Direxion or ProShares is effectively short all he has created. Not every player in every product flattens out at exactly the close of each day, but it’s certainly a force on the margins. And the bigger the move, the more you need to hedge, so it can feed upon itself. Cramer’s Evil Cabal is often a quant-ish trader or hedge fund simply evening up. And yes, that evening up can take the form of shorting into weakness and chasing strength.

Now hedgies and traders not actually short volatility can indeed pile on, knowing they can squeeze the aformentioned players. Or at least try to squeeze them. But it’s not a layup to buy at 3pm every strong day and sell 3pm every weak day. It’s perhaps a good odds move, but it’s a risk trade that gets squeezed too in it’s own right.

And we haven’t even touched on actual longs selling stocks. That’s been known to happen too.

Bottom line is it makes better TV to have some Sith Lord sitting around controlling every market in the world, but it’s a bit more complex in reality.

MW: I discuss iron condors more often than any other strategy in this blog.  Do you have
any comments specific to adjusting iron condors – perhaps deciding when to
adjust?  Or perhaps a favored method?

PB: As you know I was a big trader of Iron Condors for several
years when the VIX was in the 10 – 20 range and did them monthly with very good
success until Aug 2007 when the whole market volatility environment changed
dramatically.  When I did Iron Condors
exclusively from 2003 – 2007 I tried to make strike selections where adjusting
was not something I would have to consider often.  However, as you know markets will
occasionally make large moves and threaten the short strikes.  My experience has been that adjustments for
Iron Condors are quite limited and most either eat into your credit
significantly, or increase risk.

The only adjustment I really considered was based on time to
expiration. One common adjustment “regime”
I would use if the Put side was threatened, for example, was to close the put
spread and roll it down and close the calls and roll them down as well as long
as I still maintained a total net credit.
The goal was to simply give me more space in the time remaining for my
options to expire worthless or get to a point where I could close for a
profit. I only considered this though if
time to expiration was short. If there
was 4 weeks left to expiration then the adjustment would still leave me plenty
of time for the position to move against me while reducing my credit. However if there was 1-2 weeks and I felt the
market had a good chance of moving back away from my threatened strike then I
would do the adjustment to sort of buy me more cushion to wait out the
market.

If the market kept coming at me, I would have to accept the
loss and bail. I found in my experience
that you really only have one adjustment in an IC to give you some cushion, and
if market still will not cooperate then you get out and look for next
opportunity.

Thanks Phil. I enjoyed this conversation and am pleased to have you as my first interview. ]]> http://tradenakedoptions.com/2009/06/interview-with-philip-budwick/feed/ 0 http://tradenakedoptions.com/2009/06/im-melting/ http://tradenakedoptions.com/2009/06/im-melting/#comments Sat, 20 Jun 2009 11:52:14 +0000 gyatz http://tradenakedoptions.com/?p=678 Adam Warner, Daily Options Report, looks for evidence that the leveraged ETFs are having an effect on the closing prices of the indices that they trade.

So after all the fuss about Leveraged ETF’s causing their own late day melt downs and melt ups, is there any evidence it actually happens? I mean stocks have closed low and last or high and last forever. Has that pattern of accelerated as leveraged ETF’s gained popularity?

Just to refresh, the concept is that Third parties create these ETF’s for Direxion and ProShares, and those Third parties need to rebalance at some point each day in the direction the ETF is moving. The thought being that this large natural player was piling onto moves already in progress, in addition to hedgies and traders fronting them.

Michael Stokes of MarketSciBlog thinks that there’s not much to see here.

Now I don’t know if traders are seeing a surge in volume near the close (because I don’t trade intraday), I don’t know if leveraged ETFs are responsible for today’s higher levels of market volatility, and I don’t know if leveraged ETFs add potential systemic risk should the market make a really big move up or down (a’la Oct. 1987).

But I do know that, leveraged ETFs are not pushing the market to close at intraday extremes with any more frequency than has been observed historically.

….A simple test. The graph (click thru to see) ….. shows a 1-year rolling average of the % of days that the SPY closed in either the top or bottom 20% of its intraday range (blue, left scale) and/or the top or bottom 10% (red, right scale), from early 1993.

From today, the market has closed in the top/ bottom fifth of its intraday range (blue) 52% of the time, and in the top/bottom tenth 30% of the time, over the last year. And while this is slightly more than the average over the entire test of 49% and 28%, it’s still very much in line with historical norms.

I do believe volume patterns have changed since the popularity of these pups have increased, but that may be sector specific. Financials for example now regularly see the biggest surge in the last few minutes, whereas formerly volume peaked near the open. But it’s interesting that a basic study of price performance shows relatively minor tweaks.

Bottom line I found playing around with this trade is that it only really worked well in the financial sector. That is, if you bought SKF or FAZ in the last hour on an already ugly day, you likely had good flip if you sold it out at the bell. But a combo of everyone in the world gaming this thing, and financials just not moving nearly as much these days, seems to have ended the play