stringing butterflies together

S

stevenpaul

I was reading the interview with Tony Saliba in Schwager's __Market Wizards__ about how Saliba would "string together" butterflies to create a broad profit zone. I can manage to produce nice, broad profit zones with calendar spreads (at the cost of excessively long vega exposure), but trying to string together butterflies seems to be impossible. There's always that deep risk zone between the the profit zones. Is it indeed possible to create a seamless profit zone with flies, comparable to that of a multi-calendar spread position, and if so, could we get a little discussion going about it?

Thanks for your feedback, folks.
 
I guess it is possible if you leg into them. I.e. away flies cost less than atm flies so u could put on an away fly, stock goes there, put on the other side cheap, until u leg into a multi legged fly for very cheap . Generally, you have to take some kind of greek risk to leg into these relatively riskless position. In above example you took delta risk. Some traders take gap/gamma risk where they sell a straddle, leg into the wings a week later to get a good price.
 
Quote from stevenpaul:

I was reading the interview with Tony Saliba in Schwager's __Market Wizards__ about how Saliba would "string together" butterflies to create a broad profit zone. I can manage to produce nice, broad profit zones with calendar spreads (at the cost of excessively long vega exposure), but trying to string together butterflies seems to be impossible. There's always that deep risk zone between the the profit zones. Is it indeed possible to create a seamless profit zone with flies, comparable to that of a multi-calendar spread position, and if so, could we get a little discussion going about it?

Thanks for your feedback, folks.
More...

Won't work. It worked for Saliba because he was a market maker that was getting the edge on all 4 legs and back in his day that edge was huge! Options had .50 to 1.00 wide bid asks spreads, sometimes more.
 
Legging in or being a market maker gives you a better risk profile than trading the naturals but doesn't prevent you from obtaining a position with a broad profit zone. Here's the verrrrry long answer:

Deep risk between the profit zones of two butterflies occurs when the short strikes are not adjacent. IOW, when the short strike of one butterfly does not cancel out a long strike of another. For example (all of the following are puts):

+ 805 - 800 + 795 and + 795 - 790 + 785 (ignoring the ratio)


If they do cancel then you get that broad profit zone:

+1 805p
-2 800p
+1 795p

and

+1 800p
-2 795p
+1 790p

Combine the above two and you end up with:

+1 805p
-1 800p
-1 795p
+1 790p

That's a pair of verticals whick looks somewhat familiar but not exactly what we're used to seeing (see below). Add the next lower adjacent butterfly:

+1 795p
-2 790p
+1 785p

and combine with the previous combination, you get:

+1 805p
-1 800p
-1 790p
+1 785p

So adding add'l butterflies at adjacent strikes simply results in a similar position where the short strikes are getting further apart with a wider profit zone with lower amplitude.

Now if you take that higher strike vertical from the most recent position and convert it to its equivalent call vertical then you end up with

+1 805c
-1 800c
-1 790p
+1 785p

which now looks familiar -- the iron condor :eek:

So it is indeed possible to create a seamless profit zone with multiple flies comparable to that of a multi-calendar spread position but I have no idea why one would do it that way since it's commission and slippage intensive and can be achieved by just doing an IC.

The short answer is a question :).

What strategy has a somewhat similar risk profile to your multi-calendar spread position (I'm assuming different strikes in your calendars).

Answer: An iron condor (tho the tails behave differently).
 
Thank you all very much! Good feedback from all of you. To Spindr0: What a generous, thorough reply! The first question that comes to mind, is how can we broaden the profit zone of condors? Judging by some of the responses, notably Maverick74's, it would seem impossible using natural quotes to pull it off, but that was concerning classic flies. I was getting a broader zone with double broken wing butterflies, but I'm not impressed with the risk/reward ratio. With calendars, we can achieve some pretty impressive results, but the vega exposure seems too damn high for purposes of a theta harvesting strategy. For example, with Dec/Jan calendars on Spy at 110 and 119 using puts, and 126 using calls (to avoid ITM options), we get a profit zone that extends from 107 up to 127. That wide of a zone with 3 weeks of market exposure seems like a good deal to me. Vega on the position is $22.26. That seems a little high. It's 15% of the maximum profit. Am I right in finding that excessive? It would be different if I had a clue where IV was going in SPY. The nice thing about flies and condors is that vega, while obviously negative, doesn't play as prominent a role, and is something of a moot point come expiration where the spot price is all that counts. With calendars, you've got to hope the long is still worth a damn at or near expiration or the theta gains are irrelevant. Hence my preference for a butterfly type structure.

Thanks again, and send over some more of your wisdom, fellows!
 
Quote from stevenpaul:

Thank you all very much! Good feedback from all of you. To Spindr0: What a generous, thorough reply! The first question that comes to mind, is how can we broaden the profit zone of condors? Judging by some of the responses, notably Maverick74's, it would seem impossible using natural quotes to pull it off, but that was concerning classic flies. I was getting a broader zone with double broken wing butterflies, but I'm not impressed with the risk/reward ratio. With calendars, we can achieve some pretty impressive results, but the vega exposure seems too damn high for purposes of a theta harvesting strategy. For example, with Dec/Jan calendars on Spy at 110 and 119 using puts, and 126 using calls (to avoid ITM options), we get a profit zone that extends from 107 up to 127. That wide of a zone with 3 weeks of market exposure seems like a good deal to me. Vega on the position is $22.26. That seems a little high. It's 15% of the maximum profit. Am I right in finding that excessive? It would be different if I had a clue where IV was going in SPY. The nice thing about flies and condors is that vega, while obviously negative, doesn't play as prominent a role, and is something of a moot point come expiration where the spot price is all that counts. With calendars, you've got to hope the long is still worth a damn at or near expiration or the theta gains are irrelevant. Hence my preference for a butterfly type structure.

Thanks again, and send over some more of your wisdom, fellows!
More...

Steve, when you mention theta harvesting, it sounds like you got that from an option seminar. I really cringe when I hear that. I know 100's of guys that have tried to string out flys, condors and calendars in the effort of "widening" the profit zone. And of all the guys I have known to use these strategies, not one of them profitable. I think part of the problem lies in the fact that there is so much negative edge with each leg you add so all these layers just dig you deeper in the hole while at the same time lowering your payoff.

I've seen guys get really creative and turn a simple position into a 30 legged monster all because they are trying to "harvest" theta. I honestly think you would be better off selling straddles if you are trying to harvest theta. I've never seen these 20 legged spreads work out.
 
Quote from stevenpaul:

...I can manage to produce nice, broad profit zones with calendar spreads (at the cost of excessively long vega exposure), but trying to string together butterflies seems to be impossible. There's always that deep risk zone between the the profit zones.

Is it indeed possible to create a seamless profit zone with flies, comparable to that of a multi-calendar spread position, and if so, could we get a little discussion going about it?
More...
Could you clarify if you're you trying to "string together" the positions all at once or whether you're adding these positions as you manage an overall inventory?
 
Quote from stevenpaul:

The first question that comes to mind, is how can we broaden the profit zone of condors?

Sell a wider strangle. Overwrite. But can you live with that risk/reward ratio?


The nice thing about flies and condors is that vega, while obviously negative, doesn't play as prominent a role, and is something of a moot point come expiration where the spot price is all that counts. With calendars, you've got to hope the long is still worth a damn at or near expiration or the theta gains are irrelevant. Hence my preference for a butterfly type structure.

You answered your own question. If you go diagonal, far month value is a ? mark at near term expiration . With same month butterflies and condors, IV isn't as much of a factor since change in all legs is reasonably similar.
More...
 
You guys are awesome. Great community we've got here.

Thanks Maverick for your candid input. Good feedback on what happens when spreads are excessive of legs, especially when the goal is theta proceeds. That kind of real-world experience is worth more than mere theory from books or software. No, I've never attended any seminars, and as far as I know, the term "harvesting" is purely my own. Say, if my natural manner of speaking has a seminar ring to it, maybe I ought to get into that line of work.:D

Sonoma, I was originally thinking I would try to put them on all at once. That way, you could know upfront what expectations to have. MushinSeeker illustrated how a portfolio of flies could be accumulated gradually, following helpful market gyrations. It may be necessary to do it that way, if one were going to try this at all.

Spindr0, yes, in the end, the classic condor, perhaps with a wider short strangle, may be the best version of the type of trade I'm going for here.
 
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