The Perfect Option position
- Thread starter Maverick74
- Start date
Maverick,
Do you still assert that this methodology is "The Perfect Option position"? If recall correctly, you combined a butterfly with a backspread. Have you refined or modified your position? Would you say this is as "good" as it gets regarding a safe and profitable strategy?
thanks,
Walt
Do you still assert that this methodology is "The Perfect Option position"? If recall correctly, you combined a butterfly with a backspread. Have you refined or modified your position? Would you say this is as "good" as it gets regarding a safe and profitable strategy?
thanks,
Walt
While we are awaiting Maverick's reply, I would like to suggest that this position is not perfect. Like any other position, it can make money or lose money. Yes it can make more than it can lose but then so too can a naked long option.
The question is: 'What can hurt this position?' Once you know that then you can put your money on the line and look for the signs to get out when it is not working out or when the risk reward becomes undesirable.
A slow grinding market working its way to the long strike but does not significantly exceed it can cause a liability equal to the amount between the short and long strike. Even with the underlying going beyond can hurt as the long option strike 'swims' down the skew curve, traveling at lower and lower implied volatility.
One should keep in mind that this is no different to a long call butterflu plus a long strangle. If the strangle costs way more than the butterfly can profit, then what is the point of this particular configuration? If the strangle is however dirt cheap then it is a consideration but then the butterfly is quite rich - perhaps too expensive to buy.
This is not always a 'perfect position' but you can use it when market activity calls for it.
The question is: 'What can hurt this position?' Once you know that then you can put your money on the line and look for the signs to get out when it is not working out or when the risk reward becomes undesirable.
A slow grinding market working its way to the long strike but does not significantly exceed it can cause a liability equal to the amount between the short and long strike. Even with the underlying going beyond can hurt as the long option strike 'swims' down the skew curve, traveling at lower and lower implied volatility.
One should keep in mind that this is no different to a long call butterflu plus a long strangle. If the strangle costs way more than the butterfly can profit, then what is the point of this particular configuration? If the strangle is however dirt cheap then it is a consideration but then the butterfly is quite rich - perhaps too expensive to buy.
This is not always a 'perfect position' but you can use it when market activity calls for it.
Walt...as Charlie mentioned, there is no such thing as the perfect option position. The title of the thread years ago was chosen to both attract attention and get one to think about the essence of that statement. A more appropriate phrase would possibly be "the optimal option position". For those of you who have read the thread all the way through you will see that I am not the creator of this position. The position is actually explained in detail in the book "Option Market Making" by Jan Allen Baird.
The position is optimal because it combines attributes that market makers generally would like their position to have. That is one that is short dollar premium in the front month and long vega in the back. This position would allow one on the floor to scalp around the position to pay for the back month options while maintaining an unlimited upside/limited risk profile.
Baird was not the only one to trade in such a way. Market Wizard Tony Saliba also traded long flys in the front with extra wings in the back and scored two large payoffs early on in his career. One, in the options of Teledyne during a takeover play and another during the crash of 87.
I don't wish to discuss my personal trading on a public forum but I do trade a strategy that exhibits the p&l profile of this position. As I have stated many a times on this board, there is no such thing as a good or bad strategy, only good or bad traders. I'm sure Charlie will attest to that. You can give a guy all the edge in the world, and if he can't trade, sooner or later he will blow out.
Too many people are searching for the grail. I've been teaching options for 4 years in Chicago (for free) to the public. And one of the things I emphatically mention is that at the end of the day, if you are not a damn good trader, you will not survive trading options, futures or stock for speculation. No one wants to hear that.
This thread was more an academic exercise years ago that served it's purpose. I am very happy to see that some have gotten a lot out of this thread. I'm not sure a thread like this would have been possible with the current roster of ET members. This thread was a good example of what ET was years ago but probably won't be again. But it will be in the archives for future reference.
Exactly.
This has been a discusion of a 3 or 4 strike version of a Market Maker type position involving dozens of strikes in several months that will allow the Market Maker to survive any type of move. Basically the MM wants extra long wings so that the inside closer short premium can make money day in and day out. The cheap wings serve to kick in and create the long gamma and thus favorable deltas needed for the nightmare moves that show up without notice. I worked with Tony Saliba from 1989 to 1994 and he was the Master at Position Disection and Harvesting Butterflies embedded in his positions.
Grow into it, if you are new, by trading small and let your own experience be your greatest teacher.
This has been a discusion of a 3 or 4 strike version of a Market Maker type position involving dozens of strikes in several months that will allow the Market Maker to survive any type of move. Basically the MM wants extra long wings so that the inside closer short premium can make money day in and day out. The cheap wings serve to kick in and create the long gamma and thus favorable deltas needed for the nightmare moves that show up without notice. I worked with Tony Saliba from 1989 to 1994 and he was the Master at Position Disection and Harvesting Butterflies embedded in his positions.
Grow into it, if you are new, by trading small and let your own experience be your greatest teacher.
There is no inherent model-dependent advantage to any position, but it will always make sense [to me] to be short guts and long wings. Your stops are long convexity with the bonus of flipping gammas when the position blows-out. In practice, my best dispersion/replication positions have always come from building inter-market flies.
The OOPs is a good passive strategy in many situations with the risk-hole at the wing-strike on the fly, per highfreq. lol
IMO, the only acceptable [risk] short gamma positions are long flies and calendars. Why sell a backspread when you can own the fly for a few pennies more?
How can you sell the calls if you haven't bought the puts!? Sell the vol Pink Floyd
The OOPs is a good passive strategy in many situations with the risk-hole at the wing-strike on the fly, per highfreq. lol
IMO, the only acceptable [risk] short gamma positions are long flies and calendars. Why sell a backspread when you can own the fly for a few pennies more?
How can you sell the calls if you haven't bought the puts!? Sell the vol Pink Floyd
Amen to that. For all you options learners out there - it's all about structure. Think: where am I long premium, and where am I short premium? If you're short premium at or near the money, and long premium away from the money (both up and down), then you've got the "optimal position" that this thread is essentially all about.
Don't spend too much time worrying about specific "named" strategies such as butterflies, flies, condors etc. Don't feel bound by the symmetry of one of the "named" strategies. Sometimes you'll find an adjacent strike is more liquid and trading at a better implied volatility. Don't hesitate to substitute it. Of course, that requires that you stop thinking only in terms of what happens at expiration, that you become familiar with your greeks, and comfortable with the use of a simulator to play "what if" games so you understand the risk parameters of your position - something you will need to do to anyway to become successful.
If you're short premium at or near the money, and long premium away from the money - short the middle and long the wings - that position has lots of great attributes. In a huge surprise move the wings act as a "safety net" and save your butt - maybe even make you rich. If nothing happens and IV drops, you will magically get shorter and shorter vegas. You can play whatever games you like in the middle, knowing that you are protected in the event of a giant move.
This general structural truth is, to me, the main lesson to be learned from this thread.
I think it is also one of the original reasons for the "smile" of volatility. If it is desirable to buy wings and sell the middle, then the price of the wings goes up. Later on the shape of that smile changed in many cases as other factors exerted a stronger influence.