I gamed out all of the various scenarios and felt that I had a good understanding of how I would make and lose money on the trade. Sometimes, though, you depend on a few key assumptions without realizing it.
In July, I bought the front month options (August/September) and sold a back month (December) on VXX thinking I would a) earn the heavy skew present in the distant options and b) earn the rising deltas associated with front month, which would increase faster than the back month. As last week and today showed, I was certainly correct to expect higher volatility.
I assumed that long, nearby calls would take care of the margin requirements for the naked December short calls. Wrong! Apparently, options margins at Interactive Brokers only offset when you sell the front months and go long the back months. I noticed, somewhat concerned at first and later with alarm, that the margins on the position grew exponentially every day even though I was making money on the trade. Friday’s VXX open forced me to a point where I obviously would not be able to maintain the position as volatility picked up.
The important take-away from this experience is that it’s important to go into a new trading situation small, even if you think you have everything figured out. Trades like this make me feel a little more accomplished. Not because I made a lot of money (I barely broke even), but because six years ago I would have let this turn into a margin call.
Here are the good things that happened:
1) I expected that I could get away with heavily margining the position under any scenario. Knowing that my forex and equities are my forte, I thankfully opted to go with only 25% of what I thought my margin could sustain in the worst case scenario. This was in spite of feeling like this was potentially the trade of a lifetime.
2) Cutting the trade before it got out of hand. Although it took a few days to piece together what was happening, I decided to avoid the expanding margin requirements before it affected other long term trades.
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