The Perfect Option position

[TempusFugit]

I just discovered this site and was so impressed that I registered with ET...(normally wouldn't for fear of spam).

On behalf of all the lurkers out there, thanks to the posters for their honest insights and civil tone.

 

[Maverick74]

Quote from TempusFugit:

I just discovered this site and was so impressed that I registered with ET...(normally wouldn't for fear of spam).

On behalf of all the lurkers out there, thanks to the posters for their honest insights and civil tone.

Welcome to the option boards. Learn and prosper!

 

[Maverick74]

Moving the thread back up.

 

[weewilly]

Just read this interesting thread. You can actually lose quite a lot with the "perfect position." Say you put it on just as stated. Distant long wrangle, near long butterfly. Much to your dismay, the underlying moves to 90 at near-term expiration, so you suffer a total loss on the fly, but no problem, next month will be better, so you roll another fly, centered around 90. Underlying moves back to 100. Darn, a total loss on that fly too, so you buck up and roll another fly around 100. Underlying moves back down to 90 and you lose again. You keep laying out the flies and they keep whipsawing you for a total loss. Finally, the underlying ends up at exactly 95 or 105 at wrangle expiration, so you suffer an agonizing maximum loss on that too.

The position is quite vunerable to moderate whipsaw swings of underlying.

wee

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Basically what I had was a butterfly on the front month which would be done for a credit.

+1 put @ 95
-1 call @ 100
-1 put @ 100
+1 call @ 105

+2 put @ 95
-1 put @ 100
-1 call @ 100
+2 calls @ 105

Long Wrangle!

 

[Maverick74]

Quote from weewilly:

Just read this interesting thread. You can actually lose quite a lot with the "perfect position." Say you put it on just as stated. Distant long wrangle, near long butterfly. Much to your dismay, the underlying moves to 90 at near-term expiration, so you suffer a total loss on the fly, but no problem, next month will be better, so you roll another fly, centered around 90. Underlying moves back to 100. Darn, a total loss on that fly too, so you buck up and roll another fly around 100. Underlying moves back down to 90 and you lose again. You keep laying out the flies and they keep whipsawing you for a total loss. Finally, the underlying ends up at exactly 95 or 105 at wrangle expiration, so you suffer an agonizing maximum loss on that too.

The position is quite vunerable to moderate whipsaw swings of underlying.


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Basically what I had was a butterfly on the front month which would be done for a credit.

+1 put @ 95
-1 call @ 100
-1 put @ 100
+1 call @ 105

+2 put @ 95
-1 put @ 100
-1 call @ 100
+2 calls @ 105

Long Wrangle!

Actually, I believe I have stated this already on this thread that is exactly what you would not do. The purpose of this play is not keep rolling new butterflies. In fact the fly really doesn't do a whole lot for this position. It's purpose is to allow you to be backspread on the far month for anywhere from a small credit to a small debit. That's it!

Yes a by product of this play should the stock not move and stay at the center strike, then yes, you will earn a profit on the spread by locking in a nice gain on the front month fly and now you can hold the wrangle for free with unlimited upside!

I also have stated several times on this thread that there is risk as you approach the front month expiration. It's not a huge risk but a small one. As you approach the wings of the front month fly you are going to risk locking in a small loss on that fly if the options expire there. However having said that, by having the backspread on the far month that will cushion the blow you would experience had you just put on a front month fly. That's the beauty of the position.

See if you would do these trades separately you would have two totally different risks. If you just did the front month fly you risk have the stock making a big move to the wings and locking in the max loss. If you just did the backspread, you would be exposed to the theta of that position and the long premium. but, by combining the two, both the strengths and the weaknesses compliment each other. So by having the stock move to the wings of the front month will kick in the backspread to avoid any large losses and by having the fly on the front month, you avoid large losses by holding a long premium position that doesn't move. Hence the perfect option position!

Actually the politically correct way to say it is rather it's the optimal option position. So I will sum up this post by saying, if you put on this play correctly, you will never have a large loss!

 

[weewilly]

Mav,

The theme is a familiar one: to collect premium from a pos theta/neg gamma front month position in order to mitigate the cost/risk of a neg theta/pos gamma back month position.

I wanted to point out, however, (and sorry if this had already been stated, as you say), that there are loss zones between the break-even point(s) of the front fly and the break-even point(s) of the longer-term backspreads. You can lose on both.

The person who initiates this position would (typically) want the underlying to sit in the profit zone of the fly until near-term expiration and then move into the profit zone(s) of the back spreads. If the fly goes out a winner and, as a result, happens to pull the wrangle's max loss points (low points of the W) up over the zero line, then you would indeed have a truly risk-free position.

wee

 

[Maverick74]

Quote from weewilly:

Mav,

The theme is a familiar one: to collect premium from a pos theta/neg gamma front month position in order to mitigate the cost/risk of a neg theta/pos gamma back month position.

I wanted to point out, however, (and sorry if this had already been stated, as you say), that there are loss zones between the break-even point(s) of the front fly and the break-even point(s) of the longer-term backspreads. You can lose on both.

The person who initiates this position would (typically) want the underlying to sit in the profit zone of the fly until near-term expiration and then move into the profit zone(s) of the back spreads. If the fly goes out a winner and, as a result, happens to pull the wrangle's max loss points (low points of the W) up over the zero line, then you would indeed have a truly risk-free position.

wee

Yeah, I went over all the loss points on this long thread. However even the loss points are small losses. And yes, the perfect scenario would be for the stock to sit still and capture the fornt month premium then make a large move over the next 6 months or so.

However, like I pointed out, I would never keep putting on flies month after month to capture more premium. There is no need for that and really no upside in doing that. If you really wanted to you could just sell the front month strangle and turn it into a long calendar but then you take away the unlimited upside so I would not recommend this.

 

[weewilly]

On a more timely note, I will be expecting the market to rise on this Saddam capture event, further lowering implied vols. Might be a really great opportunity to get some inexpensive positive gamma working during the next few days.

Dollar should pop too.

hey Osama, you're next pal.

wee

 

[Maverick74]

Quote from weewilly:

On a more timely note, I will be expecting the market to rise on this Saddam capture event, further lowering implied vols. Might be a really great opportunity to get some inexpensive positive gamma working during the next few days.

Dollar should pop too.

hey Osama, you're next pal.

wee

Yeah it's events like today that make it so risky to be short premium. This is why if you ever do have short premium you should be long backspreads in the far month. Oh wait, that's where the perfect option position comes in! LOL.

 

[nitro]

Quote from dagve:

I obviously didn't explain what I meant clear enough. I'm not advocating fly's in the back months. I wanted to point out that the fly that you recommend initiating in the front month is an iron butterfly (+1 95 p/-1 100c/-1 100p/+1 105c). I am suggesting putting on the synthetic equivalent as an alternative ( +1 95c/-2 100c/+1 105c or +1 95p/-2 100p/+1 105p). Same break even profile and greeks profile.

This is clearly correct.

I knew a guy in the T-Bill pit that did really well spreading the fronts against the backs in the '80s in a similar manner.

nitro