Virtual Risk Free Spread

Point taken faith... However, there are a few ways to manage the IV reduction. I could transact with 30 - 90 day expiration dates or I could choose to liquidate within 12 hours after the earnings report. Hopefully the underlying asset would have made a substantial move within this 12 hour window.

Walt
 
Quote from jones247:

USG is due to report on tomorrow @ 11:00 AM Est. The following represents the data as of 4:00 PM 1/28/08:
Market price = $33.25

Transactions to structure:
Buy 1 call @ 3.70 - $30.00 strike
Sell 2 calls @ 1.95 - $32.50 strike
Buy 1 call @ 0.80 - $35.00 strike

Sell 1 call @ 1.95 - $32.50 strike
Buy 2 calls @ 0.80 - $35.00 strike

Sell 1 put @ 2.80 - $35.00 strike
Buy 2 puts @ 1.55 - $32.50 strike

Although I could combine the entries of the call backspread into the butterfly, I intentional separated it for demonstration purposes.

The total cost of this structure (not including commissions, which is immaterial with a brokerage like IB) is $65 per contract (100 shares). Although there may be slippage, since I would probably hold them until expiration, unless a better opportunity arises, slippage would not be a major issue. Nonetheless, if slippage is my only major concern, then I'm in great shape with such a strategy.

Walt
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Just to add to what already has been said, if the stock expires at 35 then your butterly is at it's max loss, your call backspread is at it's max loss and your put backspread is at even/small loss depending on how much the debit/credit was. So overall you have a loss.

Using mid prices as fills - total cost $40 (highly unlikely fill) your max loss at expiry is $290 @ 35 (with your cost of 65 the loss is 315). Upside b/e 37.90, downside 29.60.

The position is slightly delta negative, gamma positive, theta negative and vega positive. So if vol drops you lose, which is certain to happen since Feb is 1800bp higher than Mar.

Slippage is a major issue! You got 0.60 bid/ask spread on the fly, 0.35 on the call backspread and 0.45 on the put backspread.
 
:confused: At expiry, it's breakeven from 30-35 so you're out cost. Your thingy looks kinda long stranglish to me. IMO - option comms are not immaterial. An eqivalent position could be done for less assuming that you could adjust size.
 
Quote from neophytenate:

:confused: At expiry, it's breakeven from 30-35 so you're out cost. Your thingy looks kinda long stranglish to me. IMO - option comms are not immaterial. An eqivalent position could be done for less assuming that you could adjust size.
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I agree, just buy a 32.5/35 strangle and don't complicate things! Your cost is 2.35, so your b/e points are 30.15 and 37.35.
 
Jones assuming you have 12 hours. They could crush the vol much quicker. So that is where your risk is. Also as mentioned there are easier ways to get the same risk/reward profile by looking at straddles or strangles. Alot less legs to deal with.
 
Quote from MTE:

Just to add to what already has been said, if the stock expires at 35 then your butterly is at it's max loss, your call backspread is at it's max loss and your put backspread is at even/small loss depending on how much the debit/credit was. So overall you have a loss.

Using mid prices as fills - total cost $40 (highly unlikely fill) your max loss at expiry is $290 @ 35 (with your cost of 65 the loss is 315). Upside b/e 37.90, downside 29.60.

The position is slightly delta negative, gamma positive, theta negative and vega positive. So if vol drops you lose, which is certain to happen since Feb is 1800bp higher than Mar.

Slippage is a major issue! You got 0.60 bid/ask spread on the fly, 0.35 on the call backspread and 0.45 on the put backspread.
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Good points MTE... in reality, what are the odds that it would expire exactly at $35. Every option method, sans reversals/conversions, will have some mathematical chance of a loss; however, I don't know of another method that allows a credit position or slightly debit position upon entry with such a HUGE probability (not merely possibility) for profit while limiting one's downside risk. Strangles or straddles may seem more reasonable, but the cost to enter such positions makes them less favorable than this system, especially since the potential and probability for profit is no better with a strangle or straddle as compared to this system... IMHO...

Walt
 
Quote from MTE:

I agree, just buy a 32.5/35 strangle and don't complicate things! Your cost is 2.35, so your b/e points are 30.15 and 37.35.
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It's hard to argue against this point, gentlemen. Although I would be tempted to cover the cost of the strangle by selling ITM options against each strangle position at a 1:2 ratio. Of course, this then becomes a call backspread and a put backspread without the butterfly.

Walt
 
Quote from Steve_IB:

Jones, You can view the profile in Risk Navigator in IB Similar to the attached
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Thanks Steve...




QUOTE]Quote from bigbiscuit:

Heres the thread Maverick set up... Baird talks about something similar in his book Option Market Making

http://elitetrader.com/vb/showthread.php?s=&threadid=24449&highlight=perfect+option [/QUOTE]

Thanks for the thread reference bigbiscuit... If someone as experienced as Maverick advocates a system similar to the one I'm proposing in this thread and it's supported by Baird as well, then such votes of confidence provides a big boost for me. I started the thread, but it's soooo many pages... it'll take me a while to complete it, but I eager to comb through it completely.

Walt
 
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