This is one of my all-time favorite trades, mainly because it is beautiful to see your thesis play out exactly as you imagine. Also, while macro trading is not generally my forte (I don’t monitor where prices of assets are moving on a day to day basis), I felt strongly that there was a mispricing in this situation.

The trade was to buy $142 (atm) SPY puts for DEC 31st 2012 and sell the same strike puts for a week earlier (I don’t remember the exact date it was maybe DEC21, it doesn’t really matter). The net price I paid was equal to ~0.25% move in SPY, or about $0.34, and I put the trade on in early December 2012. The The DEC31 options were a slightly less liquid maturity, and I felt like they were just lazily priced using a term structure rather than thinking about the pending fiscal cliff.

The thesis was that Congress was going to take until the very last minute to deal with the fiscal cliff, especially given the Republican Congress. I felt like there would be a tremendous amount of jawboning by both political parties in an attempt to improve deal terms, and there was a chance we could even go over the cliff given the recent congressional elections as every elected official had political capital to work with. This uncertainty would obviously result in increased vol and a market selloff. The downside was only $0.34 (~0.25% move) and the upside was maybe 12x (I felt a 3% down move could potentially occur in less liquid markets at year end if both sides were not coming to the table and investors wanted to protect a good year).

The trade worked perfectly, and the market dropped a few percentage points during the last week of the year as it looked like a deal might not get done, and I slowly took profits. I still had maybe half of the position on DEC31 I believe futures were down hard pre-market and I should have sold (buy the story, sell the actual vol), but I was a bit greedy and held out too long. I still made ~5x+ on that trade. It may have been relatively small capital at risk, but it was the beauty of the trade, not necessarily the profit in absolute dollar terms, that made being correct so rewarding.

Volmanac sometimes utilizes similar options strategies when we believe we have an informational advantage given certain proprietary data, allowing us to take what outsiders would view as additional risk.