Friday, January 20, 2006

Bloody Expiration

As of this writing, OEX is through 575 and Dow through 10750 on the way down.

Quadruple witching or not, I admit, we did not expect to see this much red today. The DIA 109-108 short spread looks terrible here and the only consolation we have is that we lightened up a lot on it at the down open.

Most of our short gamma positions are holding well into this slide even though many of them are getting close to the strike. This surely puts a bit of a damper on our performance for this expiration cycle, but since our main strategy is short vol/short gamma, that's the nature of the game. You take in lots of premium and then you give up some.

The most disturbing factor about this action is that OEX and NDX are through several major strikes - a possibility that the whole market didn't seem to be pricing in. I personally find this overdone in the very short term as it is a rare occasion for the indices to get so severe on an expiration following a long cycle of very benign action.

From a near term perspective this feels like a normal continuation of the Wednesday's leg down, which in our view currently amounts to an extended correction. Having moved this far it would be constructive to see the market trade just below the levels established on Jan 3rd (For the Dow and SPX), where a high-probability long signal would be triggered (in our prop model).

Overall, our stance is unchanged - with a market long bias and vol spiking, selling Feb put premium is warranted and as we wade through the bloody streets, that's our order of the day.

Cheers,
/Dmitry

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