Swing trading with Butterflies

Global OptionsTrades said:
Good question @trade4succes

The answer is not binary.

I looked at volatility in some detail some time ago and couldn't find a bankable edge that I could exploit from trading volatility alone (*). My directional calls generally seem to be pretty good - although not so much this week!

My strategies / methodologies:
  • Directional (swing) trades ising vertical spreads further away from AtM are more purely directional, and relative volatility doesn't have a huge impact
  • where possible - depending on skew etc - I bring the short side in closer to AtM to harvest gains from excess volatility risk premium, as you put it.
  • the body for Butterflies can be far OtM or closer to AtM for similar reasons and also depending on my estimated / target return
  • Calendars are much more dependent on Vol movement and there would be little point in trading them without exploiting the relative impact of IV across respective expiration terms.
  • (*) Outside of this journal I do a couple of other things, including a 'no brainer' momentum strategy on individual equities to participate in changes in volatility over a month or two, which makes a useful profit vs the work involved but is not a particularly interesting discussion to put on a forum.
Do you trade similarly? I would welcome your thoughts.
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I do not trade at the moment (used to be a simple stocks trader), but currently am reading up on options.

My current understanding is (nothing new for you I am sure, unless I am wrong), that 1) delta one/outright strategies are a subset of option strategies, where the market is modeled as a Bernoulli distribution with instantaneous implied 50/50 probabilities (actually a bit skewed to the upside because of cost of capital). If the trader believes that the market is over/underestimating the upside probability, she goes short/long. Time isn't even important here, because if a long term trader thinks the odds are bearish short term, and long term bullish, she should go short now and go long later (abstracting away from possible liquidity/transaction cost and similar issues).

With 2) option trading, one imagines the option prices determine an implied continuous distribution over the expected price, with a time dimension added. If the trader at a certain time believes the markets odds are wrong in whatever dimension, she can set up an options position to profit from it.

Now, the reason I asked you, is because some academic articles suggest that options (at least on stock indices, and possibly others) are perennially overpriced on average (premium versus risk, i.e. implied versus realized volatility). Reading that made me wonder whether that edge is the cornerstone of all option traders, where specific situation-dependent implementations of trades are tailored as a sort of money management tool to make the harvesting operation as efficient as possible.

I understood from your answer there is no black and white answer to that, and you employ a rather fluid sort of strategy. If I were to start trading again, I would be tempted to believe the academics on face value and zero in on the allegedly overpriced premiums, but that would probably be too easy to make a good living. Because that would be similar as just always be short VIX (which, I am speculating here, doesn't do much better than a risk adjusted return of long the S&P). So my tentative conclusion is that there still is no holy grail, and all the better. Thanks for your answer, and good trading!
 
Thanks for that. I broadly agree and would respond to a couple of points, thus:

trade4succes said:
...because some academic articles suggest that options (at least on stock indices, and possibly others) are perennially overpriced on average (premium versus risk, i.e. implied versus realized volatility)...
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I also read this. The difficulty (for me) is in monetising it. I spent time, effort and money trying to profitably sell excess IV and hedge delta without success and look forward to hearing how you manage this.

trade4succes said:
...I understood from your answer there is no black and white answer to that, and you employ a rather fluid sort of strategy...
More...

I would amend this to say I employ several discrete strategies, to (attempt to) profit from different scenarios and conditions that I identify at a point in time.

trade4succes said:
...So my tentative conclusion is that there still is no holy grail, and all the better...
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Agreed! I have said before, if it was easy to profit consistently from this type of stuff, everybody would be doing it! :D
 
Global OptionsTrades said:
Unusual situation for me today. I want to turn around short directional trades (#294). The ES position expires today. At c.45 it has only 5 points downside if ES rallies. If ES falls, there is potential upside in the trade. Out of character for me but I'm watching the intraday chart!
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ES opened at >3830 with the spread at c.45.
Despite having a long signal, with little downside to doing so, I waited a few hours and closed with ES c.3780 :)

Trade date: 03 November 2022
Security: ES
Price at opening: 3,738.0
Structure: AtM/OtM Call Credit Spread
Expiry date: 09 November 2022
Strikes: 3735 / 3785
Opening Spread: 21.00
Close date: 09 November 2022
Trade duration: 6
Closing spread: 37.63
Profit / (Loss): -16.63
Profit / (Loss): -57.3%

Opened this at the same point.

Trade date: 09 November 2022
Security: ES
Price at opening: 3,781.0
Structure: AtM/OtM Put Credit Spread
Expiry date: 14 November 2022
Strikes: 3725 / 3775
Opening Spread: 21.00

...ES continued to fall and closed at 3755 :(
 
Global OptionsTrades said:
..I also read this. The difficulty (for me) is in monetising it. I spent time, effort and money trying to profitably sell excess IV and hedge delta without success and look forward to hearing how you manage this...
More...
As a first thought, I would also say selling straddles/strangles and loosely delta hedge to get a better Kelly profile. Of course delta hedging can come at a cost and eat up all theta and more. So more reliable (although slower) should be selling butterflies with positive extrinsic value.

If it didn't work for you, than I am logically deducting that either there wasn't a consistent volatility risk premium at the time, or there are some tricky practical issues that prevented a positive outcome (might be the delta hedging). I skimmed some academic papers that compared several strategies, some were more profitable than others (if at all), but not much more than just holding S&P if I recall correctly.

Global OptionsTrades said:
..I would amend this to say I employ several discrete strategies, to (attempt to) profit from different scenarios and conditions that I identify at a point in time...
More...
Right, discretionary input from an experienced trader is what I would expect to make it work (significantly outperform S&P) anyway.
 
Closing orders filled for the fly (#294) opened on Tuesday, closed in profit.

Trade date: 08 November 2022
Security: NQ
Price at opening: 11,077.1
Implied Vol 43.8%
Direction: Put
Expiry date: 11 November 2022
Strikes: 10725 / 11075 / 11425
Structure: 1 / 2 / 1
Opening Spread: 95.00
Close date: 10 November 2022
Trade duration: 2
Closing spread: 131.13
Profit / (Loss): 36.13
Profit / (Loss): 38.0%

Some of the verticals have closed and I'll update asap.
 
The approach I was using (mainly buying and selling strangles and straddles) exposed me to directional risk, which required delta hedging, which I couldn't achieve at sufficient cost that there was still a reasonable net profit to be derived.
 
The jump across the board today (c.5%) caused closing orders to fill in profit for RUT & NQ trades (#300) and ES (#303) which were all opened yesterday.

Trade date: 09 November 2022
Security: RUT
Price at opening: 1,796.0
Structure: ItM/AtM Call Debit Spread
Expiry date: 16 November 2022
Strikes: 1760 / 1795
Opening Spread: 19.59
Close date: 10 November 2022
Trade duration: 1
Closing spread: 31.00
Profit / (Loss): 11.42
Profit / (Loss): 58.3%

Trade date: 09 November 2022
Security: NQ
Price at opening: 10,943.0
Structure: OtM Put Credit Spread
Expiry date: 16 November 2022
Strikes: 10510 / 10600
Opening Spread: 20.75
Close date: 10 November 2022
Trade duration: 1
Closing spread: 7.50
Profit / (Loss): 13.25
Profit / (Loss): 19.1%

Trade date: 09 November 2022
Security: ES
Price at opening: 3,781.0
Structure: AtM/OtM Put Credit Spread
Expiry date: 14 November 2022
Strikes: 3725 / 3775
Opening Spread: 21.00
Close date: 10 November 2022
Trade duration: 1
Closing spread: 5.50
Profit / (Loss): 15.50
Profit / (Loss): 53.4%
 
Global OptionsTrades said:
Good question @trade4succes

...My strategies / methodologies:
  • Directional (swing) trades ising vertical spreads further away from AtM are more purely directional, and relative volatility doesn't have a huge impact
  • where possible - depending on skew etc - I bring the short side in closer to AtM to harvest gains from excess volatility risk premium, as you put it.
More...


I realised that one piece of my response to @trade4succes wasn't put particularly well and needs unpacking a bit as the directional swing trades can employ different strategies/structures.

The OtM Credit and Debit spreads are more dependent on theta decay, and less dependent on the IV falling for legs relatively close together.

The AtM/ItM Debit spreads and the AtM/OtM Credit spreads both utilise a short 50-delta leg, so benefit to a significantly greater extent on the reduction of IV to close in profit.

Obviously in the case of the Debits, the combination of increasing delta of the long leg (and intrinsic value in the spread) with reduction of IV of the short leg (and extrinsic value in the spread) (are expected to) work together to provide what I consider to be pretty good returns.

In the case of the Credit spreads, reduction of IV of the short leg (and extrinsic value in the spread) with theta decay on both are driving returns.

Hope this helps.
 
Long signal on oil at close yesterday so opened a put spread.

Trade date: 15 November 2022
Security: CL
Price at opening: 84.31
Structure: OtM Put Credit Spread
Expiry date: 18 November 2022
Strikes: 81 / 81.75
Opening Spread: 0.18
 
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