afterwards. This means that I can be somewhat passive when
selling before the announcement, sitting on the offer as the price
should come to me. The same idea is true when I'm buying back
the position after the announcement. I can afford to wait on the
bids.
Conversely if I was buying futures, say 30 minutes before the
announcement, in the anticipation that they would rally right up
until the release I would need to be aggressive and lift the offer. I
can't sit on the bid because the price will be naturally going away
from the bid.
Understanding this idea is crucial for the active trader because we
will generally be trading in the expectation of making a quick
230
profit on a market move. If we dither around and refuse to pay the spread, we may never get filled and miss all of the profit.
Example
Let's say we want to sell the straddle on a stock because we expect
implied volatility to collapse after the earnings are announced. On
the open of the day before the announcement, the straddle is 2.1
bid and offered at 2.5. We want to sell 20 straddles and the bid
and offer are both for 100.
Because I know that the implied volatility will generally tend to
rise until the announcement, I can afford to let the market come to
me. So, I would put in a mid-market order to sell 20 straddles at
2.3. If this doesn't get filled, then we need to try something else. I
know from back testing and previous trade results that I expect
the straddle to drop to 1.0 after the announcement. From the mid-
price this would give a profit of 1.3, but even from the bid the
profit would be 1.1. This profit projection has some uncertainty to
it but according to my own risk-reward calculus I would never
miss out on a profit of 1.1 trying to get a better fill by 0.2. I might
be able to get filled at a better price so I will do a little fishing. I
will put an offer to sell one lot and gradually walk it down,
lowering the offer until I get filled. Then I will offer the remaining
19 straddles at slightly better than that. If I don't get filled, I will
just hit the bid. The trade is expected to be profitable, so I don't
want to miss it.
By far the most important aspect of execution to an active trader is
not missing the trade. Psychologically, an easy way to avoid
missing trades is to value the trade against the bid if selling and
the offer if buying. This stops you being intimidated by the size of
the spread.
Keep in mind the expected direction of the instrument you are
trading. If you are selling into a rising market, you can be patient,
but if you are buying into a rising market, you will need to be
aggressive.
231
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Positional Option Trading (Wiley Trading) Page 25
