I'm trying to get spun up on incorporating risk reversals into the RTT and have a question about defending a big downside move. I'm looking at the 16 Nov ES trade that Tom just recently launched and he put on a 2 lot RR on day 2 of the trade which bumped the position delta up to +28 and -80 Vega. I'm curious as to how this will be defended with that much positive delta and negative vega if we get a big drop like we had back in Feb of this year. I'm playing around with the same type of trade in ONE during the Feb time frame and it seems like the only way to defend it is to flip the RRs and go big with them (like from a 2 lot to 6). Which I guess is good if the market continues down but then of course what about a whipsaw? Is incorporating RRs from the beginning of the trade now considered a viable add on like the BBs and CSs?
Defending Downside Move on a RTT With Risk Reversals Already Layered In
- Thread starter JasonT
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Not knowing anything about where the strikes are but watching the RTT presentation and based on those rules it seems that the trade is a little more bearishly started with the upper long about 1% OTM and with just a 2 lot RR I would imagine he is not planing to defend a big drop like in Feb otherwise I am sure he would have increased the lot size
If it continues to go down at this slow pace the trade can be easily adjusted by adding more RR or adjusting the BWB also with the small RR if there is a whipsaw it can be easily taken off without a big impact on the P/L
I don't think putting a RR on is a good add on unless you know the market is going to go in the same direction
The RR is more like a defensive move and it's more directional while the BWB is somewhat more neutral at the start anyway so placing the RR on a neutral trade would make the trade more directional so you can't just place it on at the beginning even when the market is going against you although looking at some of JL Lord;s trades he does that all the time but he was a market maker and he has some kind of sixth sense and knows where the market is heading and is willing to accept a draw down and wait for the market to turn around and go in the direction of the trade
I am not sure a beginner trader is going to have that kind knowledge or the guts to go through a draw down without panicking and closing the trade or making an adjustment at the wrong time and getting whipsawed
If it continues to go down at this slow pace the trade can be easily adjusted by adding more RR or adjusting the BWB also with the small RR if there is a whipsaw it can be easily taken off without a big impact on the P/L
I don't think putting a RR on is a good add on unless you know the market is going to go in the same direction
The RR is more like a defensive move and it's more directional while the BWB is somewhat more neutral at the start anyway so placing the RR on a neutral trade would make the trade more directional so you can't just place it on at the beginning even when the market is going against you although looking at some of JL Lord;s trades he does that all the time but he was a market maker and he has some kind of sixth sense and knows where the market is heading and is willing to accept a draw down and wait for the market to turn around and go in the direction of the trade
I am not sure a beginner trader is going to have that kind knowledge or the guts to go through a draw down without panicking and closing the trade or making an adjustment at the wrong time and getting whipsawed
Hi Jason! I primarily look at the spot price in relationship to the expiration tent and the shape of the 15 DTE line. I don't want the position to get too far underwater if it starts moving against me. I'll take a little heat as Joe Ross says but I'll reverse the long bias if it looks like the market is changing.
It is important to consider whether the purpose of a risk reversal setup is for hedging or profit generation. I frequently use small hedging RR "tweaks" which are established near break even cost to flatten deltas and smooth out the curves and other greeks. It is true that adding risk reversals increases the inventory of strikes, but when they are added judiciously as expiration approaches, a broad range of profitably can be established with decreased risk such that the position can often be allowed to expire. I look at the expected move over a 7 to 14 period to help establish the placement of the strikes. I tend to use strikes near the expected move extreme on the short side of the RR (calls, in the case of a downside defense) and strikes about half way from the current market on the long side (puts in the case of a downside defense).
Hi Tom,
I just wanted expand a little on your reply to this subject
When you say short risk reversal isn't that used in a bearish market ?
So if you are currently bullish biased wouldn't you be using a long risk reversal ?
So that would be the opposite of what you were saying unless I am misunderstanding the short and long terminology as it applies to risk reversals
On a related note you answered someone on this past Trading group 1 where someone asked why you switched from using the call to the risk reversal
I understood what you were saying but I started thinking since selling a put spread and buying a call spread does the same thing in terms of adding positive delta do you really need the full risk reversal ?
I mean if the market was going up away from the upper long of the butterfly and you just wanted to reduce the negative delta you could buy just 1 or 2 call spreads You would not need to sell the short spread unless you wanted to have more gain on the upside but that would make the delta more positive which is fine if that is the intent but if you just wanted to make it delta neutral would you still use the risk reversal or just the call spread ?
A long risk reversal is a bearish strategy. A short risk reversal is bullish.
You certainly could just add the long call spreads; however, if the market sits or goes the down, the call spreads will lose their full value. If you do a risk reversal, you have a "dead zone" (In Scott Rubel's words) where the loss will be limited or possibly a small gain. In the context of a RTT, you could make the case that the RTT provides the lift to the call spreads on the downside and omit the puts.
You certainly could just add the long call spreads; however, if the market sits or goes the down, the call spreads will lose their full value. If you do a risk reversal, you have a "dead zone" (In Scott Rubel's words) where the loss will be limited or possibly a small gain. In the context of a RTT, you could make the case that the RTT provides the lift to the call spreads on the downside and omit the puts.
Thanks for clarifying
I wasn't sure because I looked for the terminology and I found this website where the terminology is reversed
https://www.danielstrading.com/education/futures-options-strategy-guide/short-risk-reversal
Where a bearish strategy is called a short risk reversal
Also on this website
https://realmoney.thestreet.com/articles/08/20/2017/how-hedge-risk-reversal-options-strategy
Where a short risk reversal is also called a conversion where a long stock is protected or hedged buy buying a put and selling a call at the same strike so the graph would look like a straight line
Is the terminology reversed when it is used with spreads ?
As long as everyone here on this website is referring to the bullish strategy as a short risk reversal than I am ok with it
I just wanted to make sure there is not going to be any confusion of the meaning
As far as the call spread you are correct on the dead zone but only if you go away from the upper long
If yo do the call spread inside the upper leg than it's similar to doing a RH except you do not increase the margin
If you do it early in the trade just to correct the negative delta you would only need 1 or 2 call spreads to make it delta neutral so the upper leg will have a kink in it but it's still relatively similar to a butterfly than as time passes and the delta becomes more negative you can add 1 or 2 put credit spreads to neutralize delta and also to juice up the profits without disturbing the main butterfly too much that way the butterfly will still work in case of a pull back
I wasn't sure because I looked for the terminology and I found this website where the terminology is reversed
https://www.danielstrading.com/education/futures-options-strategy-guide/short-risk-reversal
Where a bearish strategy is called a short risk reversal
Also on this website
https://realmoney.thestreet.com/articles/08/20/2017/how-hedge-risk-reversal-options-strategy
Where a short risk reversal is also called a conversion where a long stock is protected or hedged buy buying a put and selling a call at the same strike so the graph would look like a straight line
Is the terminology reversed when it is used with spreads ?
As long as everyone here on this website is referring to the bullish strategy as a short risk reversal than I am ok with it
I just wanted to make sure there is not going to be any confusion of the meaning
As far as the call spread you are correct on the dead zone but only if you go away from the upper long
If yo do the call spread inside the upper leg than it's similar to doing a RH except you do not increase the margin
If you do it early in the trade just to correct the negative delta you would only need 1 or 2 call spreads to make it delta neutral so the upper leg will have a kink in it but it's still relatively similar to a butterfly than as time passes and the delta becomes more negative you can add 1 or 2 put credit spreads to neutralize delta and also to juice up the profits without disturbing the main butterfly too much that way the butterfly will still work in case of a pull back
Scott Rubel explained the history of the risk reversal in his book. Apparently the floor traders used the convention of a long risk reversal being a bearish position. Scott uses the terms "bearish risk reversal" and "bullish risk reversal" to avoid confusion but he also uses the terms long and short risk reversals, which as he explains, is backwards to the way people think about it unless you understand the history of it.
I agree that it can get confusing. The clearest way to reference them is to use Scott's approach of "bearish risk reversal" or "bullish risk reversal." Obviously you can't use the first letters for a useful acronym. BRR could be either bullish or bearish.
I agree that it can get confusing. The clearest way to reference them is to use Scott's approach of "bearish risk reversal" or "bullish risk reversal." Obviously you can't use the first letters for a useful acronym. BRR could be either bullish or bearish.
Thanks for clarifying
On the other website looks like they used the short call as a reference to the short RR while Scott is using the long put as the reference to the long RR but they both mean a bearish strategy
I watched again Scott's video about the RR where he tries to clarify the confusion
I guess the easiest way for me to remember is that a long put is used to hedge a stock so that would be bearish while a short put or a put credit spread is a bullish strategy
On the other website looks like they used the short call as a reference to the short RR while Scott is using the long put as the reference to the long RR but they both mean a bearish strategy
I watched again Scott's video about the RR where he tries to clarify the confusion
I guess the easiest way for me to remember is that a long put is used to hedge a stock so that would be bearish while a short put or a put credit spread is a bullish strategy