231 Butterflies

Corto · Feb 16, 2019

destriero said:
I’ve had to edit a lot as I am typing on my phone at a rest stop coming back from SF. TL;DR? How/Why exploit skew with flies.

Much obliged, this is probably the most in depth cooking recipe you've ever done. Still need help to decipher the jargon and the abbreviations, but there's a whole weekend ahead...

And where are you heading? Oregon by any chance?

destriero · Feb 16, 2019

Corto said:
Much obliged, this is probably the most in depth cooking recipe you've ever done. Still need help to decipher the jargon and the abbreviations, but there's a whole weekend ahead...

And where are you heading? Oregon by any chance?

Coming back to Tahoe from San Francisco.

Corto · Feb 17, 2019

destriero said:
Say you’re bearish and the 25D risk-reversal is trading -400 (puts are trading at 14 vol and calls are at 10). ATM vol is at 12.6% and you’re targeting neutrality which is 10 SPX above the body strike.

The targeted body strike is trading 13.7%.

You’re expecting the vol at the neutral strike to be 12.7% and perhaps 12.3% on the body. You buy a bearish 132C fly neutral to 10 points under the body and you’ll pick up 100bp in vol due to stickiness. Your deep ITM long gains a bit as well (on vol) and higher moments as it begins to become active (on moments), but offset due to skew on the (now) deep OTM two lot wing. IOW, you’ve just made a ton on delta as well as isolating the sticky-gains to the body by offsets on the (gains) ITM leg and (losses) the OTM leg.

A simplistic example of how to gain from stickiness against a rally in strip vols. The call fly is a synthetic OTM put fly and very cheap in premium terms. You can earn more in sticky-gains that the debit you pay. Not likely, but possible.

You trade the call fly in lieu of the put fly due to microstructure—as you expect the body strike to be OTM when you cover.

Got nowhere. Obviously more than I can chew. I went to google to find out about risk reversal, stickiness, etc. Funny that some links pointed to this forum.

I had no clue stickiness is a valid notion, I thought it’s a term you coined.

Anyway, I learned few things, but I’m still far from getting what you’re saying.

What do you mean by targeting neutrality which is 10 SPX above the body strike?

What do you call neutral strike? Is this related to the above?

Then you said: The targeted body strike is trading 13.7%. You’re expecting the vol at the neutral strike to be 12.7% and perhaps 12.3% on the body.

I assume targeted body strike means the strike where you’ll have 3 shorts at and you see its vol = 13.7% - correct?

Then do I expect that to drop to 12.3%? Please explain.

Bearish 132C fly neutral to 10 points under the body? A picture is worth a thousand words – I know I’m asking too much.

destriero · Feb 17, 2019

Corto said:
Got nowhere. Obviously more than I can chew. I went to google to find out about risk reversal, stickiness, etc. Funny that some links pointed to this forum.

I had no clue stickiness is a valid notion, I thought it’s a term you coined.

Anyway, I learned few things, but I’m still far from getting what you’re saying.

What do you mean by targeting neutrality which is 10 SPX above the body strike?

Structuring the fly so that the position would be delta-neutral 10 points above the body strike on the bearish 132C fly

What do you call neutral strike? Is this related to the above?

The closest strike to delta-neutrality on the spread

Then you said: The targeted body strike is trading 13.7%. You’re expecting the vol at the neutral strike to be 12.7% and perhaps 12.3% on the body.

I assume targeted body strike means the strike where you’ll have 3 shorts at and you see its vol = 13.7% - correct?

No, the strike = your prediction (target) on SPX spot.

Then do I expect that to drop to 12.3%? Please explain.

Prevailing (current) ATM vol and the "stickiness" or contamination of the target strike trading to the prevailing ATM vol as spot approaches that strike; absent a rise in strip volatility

Bearish 132C fly neutral to 10 points under the body? A picture is worth a thousand words – I know I’m asking too much.

Corto · Feb 17, 2019

Thank you very much. Will try to digest it.

tiddlywinks · Feb 17, 2019

Thank you @destriero

You make lurking around these here forums worthwhile.

jamesbp · Feb 18, 2019

destriero said:
132 flies (asymmetric payoff; debit = risk) should be traded so that they can survive a a touch of the body strike (or) traded close enough to ATM to replicate deltas in spot.

Des

... is the 132 skip strike fly you are suggesting similar to your 'pitchfork' with long wings ?

Cheers
James

tsznecki · Feb 18, 2019

@destriero Help a newb out. How does different vol regimes affect the structuring/viability of the BWBs?

Say week before Xmas vol regime vs this last week? I'd imagine it's more difficult to isolate skew when strip vols are jumping around.

destriero · Feb 18, 2019

jamesbp said:
Des

... is the 132 skip strike fly you are suggesting similar to your 'pitchfork' with long wings ?

Cheers
James

The PF is 4 legs of the vol-figure at the body strike (three short puts; one short call; same strike) so no, but both can be used for skew valuation. The PF is better for stressing and the 132 for actual structuring. The only caveat would be in the top deciles on implied and realized vols where the ATM PF will trade over the outside PF. In that case you'll need to run an ATM fly risk reversal for valuation and structuring.

destriero · Feb 18, 2019

tsznecki said:
@destriero Help a newb out. How does different vol regimes affect the structuring/viability of the BWBs?

Say week before Xmas vol regime vs this last week? I'd imagine it's more difficult to isolate skew when strip vols are jumping around.

Skew trades flat only in the top three deciles (not the bottom/low vol), so something like a PF will not register a "skew sale" but a 231/132 will be extremely cheap in terms pf premium. It's best to run a fly risk reversal to value strip and skew. ATM upside call 132, ATM downside put 231, premium valuation.