First of all, a risk reversal has a lot of vanna, meaning moves in implied volatility change its deltas. Let's say you are long 25d puts and short 25d calls. Increasing vol adds short deltas and you get long deltas when vol drops. So a risk reversal is never really neutral and you have to trade around it to keep it in check. However, you can use these properties to build decent directional positions. When you have massive call skew, you short calls, get long puts, delta hedge it neutral. As soon as the underlying trades higher towards your short strike, these calls slip from 25d towards 50 delta where IV is lower, whereas your puts slide down the skew and gain IV. Add an overall lower IV to the mix and you are short vol, long delta...exactly what you want. Getting short into call skew is basically very easy. Either get long puts or buy a ratio with long ATM puts and short OTM calls delta neutral. As the underlying falls, you're long vega plus your put strikes slide up the skew towards higher IV levels. When trading skew you HAVE to have an eye on vanna and volga, as moves in skew and implied vol heavily alter your delta and gamma profile.
thanks for taking the time to break all that down for me.. super appreciated man, everything you said clicks perfectly.. we aren't trading delta neutral, but i can definitely see where that comes into play if you're just trying to capture the skew without a directional component.. funny you mention ratios, cuz while i'm using the skew to enhance directionality instead of trading the skew directly, i've found my most effective strategies on a risk-reward and management basis to be synthetic ratios and backspreads.. in call skew, my bullish go to is synthetic put backspreads using 90/35D bull call spreads hedged with 25D puts.. in put skew we like put ladders and put ratio spreads.. bearish in put skew, i like synthetic call backspreads using put debit spreads hedged with long calls.. started with 60/40D bull spreads, then realized i had equal probability of max loss as max profit, and 80% of my trades were binary which increased the number of occurrences needed which is bad for lone investors.. i thought instead of buying "one" probability distribution i would find skewed vol curves and "buy the whole probability curve".. on a 90/35, only half my trades are binary, the delta is enough to counteract the upwards vol expansion call skew creates, and my chance of max profit is 3.5x my chance of max loss.. plus, the short is so far up you can almost always roll down to your original breakeven strike and substantially reduce risk without having to close the position, so your max loss is never really your max loss.. thanks for the advice about being bearish in call skew! that's a big help! i know exactly what you mean about the puts "sliding down the skew" - in fact, setting up my longs to slide up the skew and my shorts to slide down it is 80% of how i choose strikes.. you're the first skew trader i've spoken to who also frames it that way, i love it! i've found you can "create" call skew in equities that, on the whole, have put skew, simply by taking advantage of slight bumps and dips in the vol curve.. i try to set my strikes so my shorts are at the top of a peak and my longs are at the bottom of a dip, that way whichever direction the stock moves my short is losing vol and my long gaining it..
+1 i think it kinda went past me first time i saw it, or i'm one of the ones who doesn't get the trade lol.. but, diagonal put credit spreads then? >OTM long put @ 60DTE >OTM short put @ 30DTE >as narrow as possible while maintaining a credit >don't sell the short below the long is this the kinda set up y'all are referring to? >SPCE @ $26.89 >long july 16 $17P @ $0.63 >short june 18 $20.50P @ $0.72
I have traded a few put diagonals on single names with high IV during spike up, but for what I understand, Destriero is pointing at call diagonals on down stocks with high IV, to avoid getting crashed on volatility spike if the stocks keep going down. I have no traded those type of diagonals yet.
Mr, can we neutralize delta on a long put - short call? Do you refer to delta neutral just for the short calls or for the all ratio?
ahhh word, this is one of my go-to strategies.. the reduction in cost basis on the long call makes them extremely interesting, plus the time factor.. i do it as a bullish trade tho, not so much a bearish one, but if the IV is high enough it definitely gives you a huge cushion.. i modeled that SPCE trade, it's got some interesting mechanics if you lower the strikes even further..