What am I not seeing?

K

Kirribilli

ok, I write a straddle atm. Then I buy a long OTM call and long OTM put. How much OTM? The combined premiums collected on my shorts. If the underlying breaks though one of the OTM options, I break even. So, my risk is zero, as long as the premium collected on each side is the same.

Now, I know I must be missing something. What is it? An explosion implied volatility/time value prior to expiration?
 
Without seeing the options your looking at, hard to give an answer. Can you post the options you are looking at. Are all sold and purchased options the same expiry?
 
Kirribilli said:
ok, I write a straddle atm. Then I buy a long OTM call and long OTM put. How much OTM?
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Depends on your risk tolerance.


Kirribilli said:
The combined premiums collected on my shorts
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No ........... The OTM options will be cheaper. The trade will be for some sort of credit.

Kirribilli said:
If the underlying breaks though one of the OTM options, I break even.
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Maximum loss if an OTM option becomes ITM.


Kirribilli said:
Now, I know I must be missing something. What is it? An explosion implied volatility/time value prior to expiration?
More...



Post the exact trade you have in mind with real quotes.


:)
 
You are legging into a short iron butterfly. If the underlying breaks through one of your long legs, you are guaranteed max loss (if at expiry), assuming your pricing is not so extreme that no loss is possible. (If that were the case, you probably should have just closed out the initial straddle instead of adding legs.)

You need to look at the value of all 4 legs at expiry to convince yourself you will sustain max loss if the underlying closes past one of the long legs.
 
Ok, guys here are the numbers. Feel free to pick them apart or shoot the trade down.

Apparently this is indeed a short iron butterfly, which would work best, I know when vol is high. But the risk reward here seemed to work out ok, for me, so I am giving it a shot, at least for a while.

Long SPXPM call 2145 paid 4.12
Short SPXPM call 2075 collected 29.78
Short SPXPM put 2075 collected 37.08
Long SPXPM put 2005 paid 16.32
All legs expire June 17

My math says I have a downside of 70 (on either end), subtract the 46.44 premium collected, and my risk is 2560. This my risk/reward ratio is about 1X2,and the probably of loss is about 33% (based on delta.) The trade was instituted last Wednesday I believe and is currently up about 3.5% or about $250, not including spread slippage.
 
SPX.png

This is what I get from my grapher. The curved lines are approx every 7 days until exp, assuming constant IV. Starting SPX price was assumed to be 2080. Risk is max $2358, max gain is $4558.

If the SPX can manage to stay between about 2040 to 2150 you might grab a decent profit. Hope that it bounces back up , then maybe a good idea is to close the thing out if you have an okay profit...
 
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Kirribilli said:
My math says I have a downside of 70 (on either end), subtract the 46.44 premium collected, and my risk is 2560. This my risk/reward ratio is about 1X2,and the probably of loss is about 33% (based on delta.) The trade was instituted last Wednesday I believe and is currently up about 3.5% or about $250, not including spread slippage.
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Hi there,
I believe that your probability of loss should roughly be = cred received/width of the spread = (46.42/70)*100% = 66.3%.
33% is actually your probability of profit.
With such an efficient market, simply said, it's not possible for your cred received to be greater than your max loss while having a probability of profit also larger than probability of loss.

BTW are you from Sydney Australia by any chance? Just based on your name :)
 
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Lived there for four years. Came back to the States five years ago. Thanks for the math oversight. I'll probably close this one out early for a small profit and rethink short iron butterflies.
 
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