When underlying moves outside the butterfly (making it "out of the range") time decay and volatility-decreasing will have negative impact as less and less chances for it to expire "in the range". It's all about underlying absolute level.
Can you enlighten me further, please? Edit: I just read @marameo comment. Is that what is meant? Because if it goes out of range, you’d need an increase in vol to have a chance at bringing it back within range? And that delta hedging can attempt to hedge this risk?
When traders say they realised less vol than implied,I assume they are hedging out delta... You can have "low vol"as in a straight line one direction move with the same percentage price change every day and lose on the butterfly if you aren't hedging out delta.. You have to capture the "spread" between realised and implied vol..
I wonder why even trade implied vs realized; hedging tail risk? capture risk premium? Also, volatility skew will play a role. What if I just short the underlying when its last close is lowest of the previous 20 days (breakout pattern)? If I get stopped (market rebound) I lost 1 unit of risk, if it's a winner (market keeps going down) the payout is non linear just like options. I will do the opposite if I am short volatility.
Thought experiment: imagine you're a large institutional investor who knows, for certain, that many people will do exactly that. What would you do, and what would be the effect on all those hapless bears? (For every good, highly-liquid stock, there's a whole bunch of professionals watching it for inefficiencies of that sort. Options, on the other hand... say, twenty expirations times a hundred strikes per expiration times two sides, for each stock... I don't think the algos are quite that ubiquitous or pervasive yet.) Also, shorting a hundred shares of SPY for a month would tie up almost $30k of your capital for that long. If I sell an ATM call on that number of shares that far out, my BPR is under $6k. Your notional risk is a bit higher than mine; if the underlying moves the wrong way, my losses happen at about half the rate of yours; if it goes the right way, my return on risk is quite a bit higher than yours. If you can't use options, you're quite limited in what you can do if things go wrong; since I can, I have - well, a number of options. But I'm a relatively new, inexperienced options trader. Somebody who really knows them could probably add a few dozen (or a few hundred) more reasons. To say what I've written above another way, static strategies like this one can be (and, I'm certain, have been) arbed out. Vol hacking uses probabilities of dynamic future events, and not a sitting duck at which repeated potshots can be taken.
Options do not have constant gamma, which means your pnl is path dependent. Unlike a var swap where the payout is the difference between implied and realized. I thought Nassim talked about this in his book "Dynamic Hedging".....
It's certain risk vs uncertain reward; non linearity using the underlying. Just like options. "Cut your losses and let your profits run" An option is a weighted average of all the possible prices the underlying can reach.
You've just described every single possible type of risk/reward scenario - which, of course, includes options. By that metric, you could also claim that 1 equals 1000000... if we're counting in quadrillions, that's true to any reasonable limit. The context here is retail trading. And within that context, 1 does not equal 1000000 - nor is trading options the same as trading the underlying. I've pointed out a few of the actual differences, and you've responded with a philosophical generality which does not counter any of what I wrote. This is true, but not actually relevant. Options are derivatives - side bets - and provide much more flexibility in expressing market views than simply trading the underlying, just as side bets always have. The fact that an option is tracking the underlying does not mean that it is limited (except in the narrowest sense) to a subset of direct operations on the underlying.
Luckily Guy Cohens book is available free on pdf. I also own Al Sherbins book which is one of my favorites.