ATM Iron Butterfly - Why is it Delta Negative?

[ValZ2020]

From the book OP was referencing :
Option Trader's Hedge Fund

Pages 106 and 107, I just didn't understand how the authors have calculated the negative delta of -28 for the example they described (SPX 1200/1270/1270/1320).

 

[ValZ2020]

Isnt google long delta in the pic earlier posted by someone else

The thread starter didnt actually say what he traded if im not mistaken

It is an example from the book by Chen and Sebastian "The Option Trader's Hedge Fund". pages 106 and 107, example with SPX 1220/1270/1270/1320, ATM iron butterfly

 

[Atikon]

Thank you very much!

So, if I get this right, if I am buying the wings with the same ITM probability, let's say 16% ITM on the put and 16% on the call, the call strike will *usually* (with the normal skew) be closer to the ATM, therefore higher delta? So the positive delta of the long call will outweight the negative delta of the long put?

If so, should I buy more put "units" as the authors suggest - to flatten out the delta?

Exactly, in the normal case you would buy additional puts or short the stock to hedge the delta and you will be left with Volatility. Their whole angle is for you to find an undervalued Put Scew, one where the Put Scew is not as high as it usually is and then sell the Butterfly to gain from the IV Crush and Correction

 

[taowave]

If it's the last thing I do on this planet,its going to get you stop referring to call side vs put side and get you to talk in terms of percent of Spot

I think it's because they use Prob of OTM aka 84% for the standard deviation on each side. They are looking for a Situation were the Put Scew is reversed ("Falling Put Curve and Rising Call Curve").

Normal case:
Ppl fear a downward move more and are buying more puts, the Probability distribution (and thus the OTM Probability per Strike) is derived from which Strikes people buy the most/least. A 30 Delta on the Put Side will have a lower OTM Probability than a OTM Probability on the Call Side on the exact same delta (see Picture). Usually you would approximate via a Delta of 16 (16%ITM Prob=84%OTM Prob=1 STDV) but since the probability distribution is scewed to the put side the approximation doesn't work like 16 delta=16%ITM/84% OTM Probability. The Implied Volatility is calculated from the Option Price as well, the higher the price the higher the IV the flatter the Implied Distribution thus Delta doesn't work as a 1:1 approximation of the ITM Probability.

You will have to go to a e.g. Delta of 8 on the Put Side and Delta of 32 on the Call Side (both of them will have to move to the left on the Probability Distribution to capture the 84%) to get a OTM Probability of 84% (or ITM Prob of 16%) on both Sides. You are Selling ATM and Buying the Wings in an Iron Butterfly so:

ATM Call & Put = Put ATM Delta -50 Call ATM Delta-50 =0
Wings= Delta -8 Put Side Delta +32 Call Side

In a normal Put Scew Situation you would be Long Delta

The Authors want that you look for a steep call Curve (and flat Put Curve), so the exact Opposite of the case above. It's the Put Scew in Reverse. You are Buying the Wings at -32 Put Side Delta and +8 Call Side Delta (deltas move to the right to caputure OTM Probability). This is why they want you to buy an extra Call/Shares to isolate Volatility

Imagine the Image Attached (Normal Case with Put Scew) BUT in reverse (Call Side Steep)

I had a very similar problem yesterday: https://www.elitetrader.com/et/threads/abnormal-skew-in-delta-prob-of-otm.343276/

 

[stepandfetchit]

@ OP . Did you get adequate answer to your quest?
If you were perplexed as to "WHY", a look at where the position is placed along the volatility curve (skew) and the shape of that curve should provide insight. Most trades are placed on the left side of the "smile", where the call side iv is more compressed. Note that the low point in the IV is typically at a very high underlying value.
If you examine some Iron Flys placed above this IV inflection point, you will observe that they will have a positive Delta.

 

[.sigma]

From the book OP was referencing :
Option Trader's Hedge Fund

Ahh, after looking at the quote again, I realized. I got that book too, actually one of the better option books!

 

[.sigma]

Hello guys, happy Friday to everyone!

Have a novice question here. In a book by Chen and Sebastian (Option Trader's Hedge Fund) they give a great example of how to structure an ATM Iron Butterfly. One thing that I'm struggling to understand is why the fly ends up being delta negative?

My understanding is that both short ATM call and put will basically offset each other for the delta, while the long OTM call will have a higher positive delta than the negative delta of the long OTM put. The OTMs are of course equidistant from the ATM strikes. So why is this position then net negative in terms of delta? What am I missing?

Many thanks!

Whats so bizarre about this post, is I thought about posting the exact same thing a few weeks back.

Anyway, I have that book, its (surprisingly) very good, most option books are basic stuff, very view offer real decent info. I was perplexed by their chapter on ATM Iron Flies as well. I never saw anyone use ATR to trade fly's, so I was drawn in. ATR is one of the view technical indicators I actually use and like because its a measurement of spot vol.

I'm interested on why the delta is negative as well. I'm assuming its because of the inherent negative skew present in equities. The velocity of moneyness to the downside is much worrysome than upwards.

Also when prices go down, this increases the leverage of a company. Thus this negative skew will be present, even in ATM iron's and other option strategies. Correct me if i'm wrong but this is whats causing (slightly) negative delta. And remember how greeks oscillate with spot, when spot is under the ortho-center(body) its +delta, as spot drifts to the body, and above it, now has accumulated neg delta. Delta is telling you where it wants spot to go.

 

[taowave]

Dont have the book,but its pretty dam clear its a typo,or you are looking at one savage skew..

The wings on the fly are apx 4 percent wide. Go find me a 96 percent spot vs 104 percent spot in the SPY/SPX with a Delta differential that nets out to 28..

You find it,put the risk reversal on(delta neutral/slightly underhedge) and thank me later



Im waiting

 

[ValZ2020]

Guys another thing that I'm trying to understand from that same chapter is the concept of tightening the wings to secure the profit of the ATM Iron Butterfly, once it's there (pages 103-104).
They say it's a good adjustment technique at ~10% profit. If I get this right, by doing this you will have spent all the profit from the depreciation of the short "thorax" on more expensive longs than what you had before (tightening the long strangle). So effectively at that point you'll be left with zero profit?

And then, my understanding was that if the underlying moves sharp in either direction - the idea is that the appreciation of the "winning" long wing will be bigger then the depreciation of the losing wing due to its then-higher delta (so gamma will play to your advantage by accelerating the delta of the "winning" wing and decelerating the loss of the losing?). And then the theta will continue to take care of the short "thorax" which is now OTM?

And if the underlying remains flat - then the theta of the ATM shorts will work faster than that of the OTM longs and I win anyway?

Did I get this right and if not what have I missed?

Thanks a lot guys!

 

[stepandfetchit]

FYI: (prior topic reference) Previously I posted about why the ATM Iron Fly had negative delta. Here is a plot of IV curves (smiles) for SPX from 14 - 90 Days to Expiration for reference. The red circled region is where most trading occurs. The heavy black horizontal dots are ATM. Note: in all cases the lowpoint of the IV smile is far to the right. A picture is often helpful to understand some topics.