Trading Risk reversals

S

SillyWilly

On my bloomberg terminal I am able to scan for companies that have the highest/lowest skews. After doing some research, it is proven skew is mean reverting. So lets say company XYZ has a high skew in the 99 percentile. How might I trade a butterfly to take advantage of skew coming back down to normal levels?

Also skew is a function of implied vol. So will having this increase also make my fly cheaper?
 
I used to trade 1:2 spreads with stock to be Nuetral or just an option spread, using the delta of each strike to determine size when the skew would change. There were more opportunities when there were not so many exchanges.
 
The Backspread is short vega tho, so if the skew did flatten that would usually be from a drop in IV. So even tho you captured the skew, you lost on vega. Am i missing something?
 
SillyWilly said:
The Backspread is short vega tho, so if the skew did flatten that would usually be from a drop in IV. So even tho you captured the skew, you lost on vega. Am i missing something?
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Is that question for me? If it is, then when a large buyer come in for an OTM put, it expands. If i sell that, I look to buy less of an option with a higher delta. Then unwind when they comeback inline. Hard to do unless you are automated, but I have had clients do it manually in SPX.
 
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SillyWilly said:
On my bloomberg terminal I am able to scan for companies that have the highest/lowest skews. After doing some research, it is proven skew is mean reverting. So lets say company XYZ has a high skew in the 99 percentile. How might I trade a butterfly to take advantage of skew coming back down to normal levels?

Also skew is a function of implied vol. So will having this increase also make my fly cheaper?
More...



Skew is inversely-proportional to the vol-line. Look at 10D skew and the smile currently in the SPX. It can also be used as a timing tool, but that’s another thread.

A skew in share vol is normally a vol-shift across all strikes due to the inability to borrow for short spot. The share synthetic therefore trades under natural shares as the financing is embedded in the synthetic.
 
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SillyWilly said:
On my bloomberg terminal I am able to scan for companies that have the highest/lowest skews. After doing some research, it is proven skew is mean reverting. So lets say company XYZ has a high skew in the 99 percentile. How might I trade a butterfly to take advantage of skew coming back down to normal levels?

Also skew is a function of implied vol. So will having this increase also make my fly cheaper?
More...


Quote the reversal arb (short spot-long synth) in the ticker in question. If it’s trading near shares then the skew is natural. I can’t tell you how I model it, but you can ratio up/down flies. Skew in puts (shares>strikes; i.e. ATM put fly debit < ATM call fly debit)? Trade more ATM put flies than ATM call flies. $neutral.
 
srinir said:
I have done Atticus's pitchfork structure in SPX, when the skew is steep with good results. This is not pure risk reversal play, but makes good use of steep skew
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I am reading the thread right now. https://www.elitetrader.com/et/threads/trading-option-pitchforks.244704/

I feel like these guys come up with this stuff on their lunch breaks over at NASA.

Regarding the pitchfork, are you delta hedging to try and keep it neutral? Where are some profit targets? ie. once skew normalizes? or is there another optimal time to take off the position?

also spreads can get pretty wide with the short ITM call, i believe I should be looking forward to a few expensive haircuts. How are you finding that?
 
destriero said:
Skew is inversely-proportional to the vol-line. Look at 10D skew and the smile currently in the SPX. It can also be used as a timing tool, but that’s another thread.

A skew in share vol is normally a vol-shift across all strikes due to the inability to borrow for short spot. The share synthetic therefore trades under natural shares as the financing is embedded in the synthetic.
More...

What exactly is the vol line? If I we look at WMT skew, and my theory was that this will flatten out over the next two weeks, I could buy a 2 or 3 week Put Fly (1x3x2)? However I am short Delta if there is a reversal! Which you are saying I should keep DN.

What is the formula to see my $skew
 
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