Any traders in here who specialize in volatility skew and probabilities-based strategies?

[daytonabeach83]

okay, just to make sure i'm understanding what you're putting down:

what i'm doing is essentially chasing the same concept - setting up a skewed/positive EV bull trade that i later convert to an arb'd synthetic straddle if it rallies - but you prefer to do it as a risk-reversal because of the gamma exposure you get on the rally with the 25D put/call versus a vertical bear spread?

makes TOTAL sense as a replacement for the put ladder strat, subbing a long call for the put bear spreads, if you're bullish on put skew.. can't do r/r on call skew tho cuz i'd have to be bearish, but in put skew that makes perfect sense...

sorry for the confusion, i saw r/r and thought risk-reward not risk-reversal at first lol took me a sec

 

[Same Lazy Element]

so, i'm not thinking of opening trades as butterflies.. i'm considering opening trades, and then converting them to risk-free butterflies if the stock moves in my direction.. not a big fan of butterflies as a stand-alone trade.. i also arrange my trades such that max loss is impossible - combining long puts with bull spreads, shit like that.. or, better stated, my max loss is always lower than the cost of the trade..

The general idea of "adjustments" is bogus, IMHO. If you have a short straddle on and the original trade goes your way (i.e. you were short vol and vol dropped), why not cover it, fully or partially? Your original view is now muddled by cost of wings vs ATM and you are executing more options so you are paying more transaction costs. If your original thesis was that you wanted to have a fly on, why not have a fly on from inception?

In my skew book, I trade ratio spreads (unfortunately I can't get into the details of how I decide on the trades, structure or manage these trades) and, as @newwurldmn eluded, it's not very capital efficient but it's an isolated view on skew. People who have access to OTC can also trade "skew locks" (up-var vs down-var, hard to find good pricing these days) or trade barriers (I used to love 'em but don't trade them now). Anyways, IMHO, for a non-institutional guy, best vol/skew trades are the ones where you overlay richness or cheapness of vol/skew on top of some sort of a directional lean. While it's not my main business, I do a fair bit of directional ratio flys (a.k.a. Buttafuocos) which express a Vega/skew lean in a loss-limited way.

 

[daytonabeach83]

The general idea of "adjustments" is bogus, IMHO. If you have a short straddle on and the original trade goes your way (i.e. you were short vol and vol dropped), why not cover it, fully or partially? Your original view is now muddled by cost of wings vs ATM and you are executing more options so you are paying more transaction costs. If your original thesis was that you wanted to have a fly on, why not have a fly on from inception?

In my skew book, I trade ratio spreads (unfortunately I can't get into the details of how I decide on the trades, structure or manage these trades) and, as @newwurldmn eluded, it's not very capital efficient but it's an isolated view on skew. People who have access to OTC can also trade "skew locks" (up-var vs down-var, hard to find good pricing these days) or trade barriers (I used to love 'em but don't trade them now). Anyways, IMHO, for a non-institutional guy, best vol/skew trades are the ones where you overlay richness or cheapness of vol/skew on top of some sort of a directional lean. While it's not my main business, I do a fair bit of directional ratio flys (a.k.a. Buttafuocos) which express a Vega/skew lean in a loss-limited way.

i'm not running straddles and my thesis is not wanting to run a fly.. i'm talking about running bull spreads in call skewed stocks then converting to a butterfly/synthetic straddle on a rally.. it's basically conversion/reversal, but using skewness and stock moves instead of the bid-ask spread..

>90/40 delta call debit spread in a stock with call skew
>stock rallies
>convert to risk free butterfly

but that wasn't even really the main point of this post.. this post was asking about my understanding of kelly management principles..

also, to the point about ratios, most of my trades are basically synthetic ratio spreads.. i, also, don't wanna get into EXACTLY how i set them up, but i set trades up so as to convert the tail risk zones that are increased when trading skewness into potential profit zones.. the resulting risk profile graph is just like that of a ratio spread.. idk if your method for ratios is at all similar to mine, but ratio spread risk profiles in skewed equities is most definitely the same arena i tend to operate in..

 

[daytonabeach83]

reading back thru what you added in the edit @Same Lazy Element i think what i'm doing is in the same vein you just suggested: using the skew to find an asymmetrical risk-reward profile in my directional assumption..

again, the conversion only occurs after a strong move in my direction.. up to that point, yes, it's a directional trade where i'm buying the cheap vol and selling the high vol points in the smile..

and i modify the spreads so the risk profile resembles a ratio spread, since giving your portfolio a positive vol skew increases tail risk, i figure what better way to offset tail risk than ratios that go green on outliers?

 

[getthatintoya]

The general idea of "adjustments" is bogus, IMHO. If you have a short straddle on and the original trade goes your way (i.e. you were short vol and vol dropped), why not cover it, fully or partially? Your original view is now muddled by cost of wings vs ATM and you are executing more options so you are paying more transaction costs. If your original thesis was that you wanted to have a fly on, why not have a fly on from inception?

In my skew book, I trade ratio spreads (unfortunately I can't get into the details of how I decide on the trades, structure or manage these trades) and, as @newwurldmn eluded, it's not very capital efficient but it's an isolated view on skew. People who have access to OTC can also trade "skew locks" (up-var vs down-var, hard to find good pricing these days) or trade barriers (I used to love 'em but don't trade them now). Anyways, IMHO, for a non-institutional guy, best vol/skew trades are the ones where you overlay richness or cheapness of vol/skew on top of some sort of a directional lean. While it's not my main business, I do a fair bit of directional ratio flys (a.k.a. Buttafuocos) which express a Vega/skew lean in a loss-limited way.

Hey SLE when you mention you do directional ratio flys do you mean something like 1:3:1 with equal distance strikes? Thx

 

[getthatintoya]

@daytonabeach83 it might help put your point across with an example. It doesn't have to be a real when just xyz trading at 100 I do this this and this then convert to this when that happens. Just a thought bro.

 

[daytonabeach83]

>pay 4.00 for a 10.00 debit spread (not 1:2, i know lol)
>short strike gets breached
>sell 8 1.00 call credit spreads for $0.50 each at your short strike
>trade is now a riskless butterfly with a potential 2.00 profit

>90/40 delta call debit spread in a stock with call skew
>stock rallies
>convert to risk free butterfly

@daytonabeach83 it might help put your point across with an example. It doesn't have to be a real when just xyz trading at 100 I do this this and this then convert to this when that happens. Just a thought bro.

i dropped a couple but they mighta got overlooked

and tbc, the first quote is speaking about trading a bullish debit spread in a stock with positive vol skew

 

[MrMuppet]

A word on risk management: the best way to do this is to establish limits for the greeks.

Have a limit for gamma, vega, skew delta and vanna and readjust your positions based on greeks, not portfolio P/L. As your P/L is path dependend you need to make sure you establish boundaries that help you asses risk before the move happens.

As you're not really trading skew but direction enhanced by skew dynamics it might be useful to establish delta limits, too.

The basic position for skew is the delta neutral 25 delta risk reversal, which already is a bitch to manage.

Converting it into a fly when stock moves towards your short strike by purchasing the missing wing at lower vols is basically a new position but can help to reduce risk. Also unless you trade 1 tick wide index options, it reduces slippage

 

[daytonabeach83]

A word on risk management: the best way to do this is to establish limits for the greeks.

Have a limit for gamma, vega, skew delta and vanna and readjust your positions based on greeks, not portfolio P/L. As your P/L is path dependend you need to make sure you establish boundaries that help you asses risk before the move happens.

As you're not really trading skew but direction enhanced by skew dynamics it might be useful to establish delta limits, too.

The basic position for skew is the delta neutral 25 delta risk reversal, which already is a bitch to manage.

Converting it into a fly when stock moves towards your short strike by purchasing the missing wing at lower vols is basically a new position but can help to reduce risk. Also unless you trade 1 tick wide index options, it reduces slippage

tremendously helpful response, thanks!

the part about the greeks makes sense, especially the delta.. and you're correct, we aren't trading skew outright, we're adding the directional component and using the skew to create positive expectancies and unique management options.. we've got good ideas for being bullish in put and call skew, and good ideas for being bearish in put skew, but still struggling to find a way to be bearish in call skew that doesn't involve naked short calls lol..

however, my trading partner is starting to branch out into things like 25D risk-reversals, his account is a bit more suited to the trading costs associated therein.. could you expound on the "bitch to manage" part perhaps? i'm sure he'd be grateful to get any useful advice about how to manage the trade.. the conversion to the long fly once it becomes risk-free we understand (i think?) but where does the management difficulty we aren't factoring in occur?

 

[cesfx]

but still struggling to find a way to be bearish in call skew that doesn't involve naked short calls lol..

Also consider babysitting LVLD bull diagonals when we go lower. As narrow as you can go while maintaining a small credit. 30/60 days, 45/90, etc. A lot of ppl don't understand the trade and you can't do it on the downside; as they blowup as we drop and they are shitty bull spreads (OTM puts diag).