Thanks, this should be interesting. I know it's possible too, I just don't have the technical knowledge to create it. Looking forward to what you come up with.
While he is working already on this concept, few more observations took my attention: have you ever tried to do the same using short butterflies (multiple positions on various resistance levels) ? I have been trading them for a while and I constantly get scalping gamma opportunity. The best of them is that risk is limited and you don`t need long far month positions to hedge.
I would not want to trade butterflies off the floor. Just because after paying the spread and commissions, your edge is really not there. Guys on the floor love butterflies. They can actually put on long butterflies for a credit sometimes and have a risk free trade. I know Tony Saliba made a very nice living doing this in the early 80's. Also keep in mind, I'm not really looking at the long gamma as my profit center, I just like being long gamma because you never know what can happen. Gaps will kill you. I look at the long gamma as a way to trade around the theta. Depending on where the stock price is you can actually have negative theta with your long gamma and short vega. Plus with butterflies you want to try to leg into them very carefully and many times this becomes pure speculation if you initiate the wrong leg first, then your screwed. If I was on the floor, I think butterflies would be a great way to make a living although I hear from guys now tell me there isn't enough paper to put on the butterflies at one time. It's much harder now. If you are making money doing them great, maybe you have a really good feel for legging into them. But I like the short Calendars much better.
I don`t try to leg into them on special occasions, I just open them around resistance/support level and wait. Then I adjust them using shorts i.e. gamma scalp them. If market gives enough opportunity sometimes I can get free trade by doing this, otherwise my risk is still limited. I believe that, as you say, short calendars are better, just trying to figure out what possible profits coming from whole strategy might be vs. stock gapping down or up losses. I understand that diversification is a key, however with butterflies you can get similar opportunity as long as market gives you enough room for adjustments.
ChrisM, I have never traded butterflies before do to all the legging and stuff. Give me an example of how you trade them around support and resistance levels and how you scalp the gamma on them. I think there are a lot of good strategies if you want to speculate on stock direction. But if you want to speculate on Vol, I like the short calendars or long calendars if you want long vega. What I like about the short cal's is that you know where your out is, you have a time frame to work with. When your long vol you are basically just betting on something happening. There is no time frame. Vol can stay low for really long periods of time.
Maverick, let`s make this one: long btfly QQQ: long 32, 2 shorts 34, long 36 if market moves down you buy shorts back, when goes up back again you sell shorts again, this example is too much simplistic and this not real gamma scalping but I believe it gives you general idea of this strategy.
Yeah OK. I don't know how I would feel about being just long though once you bought back those short calls. If the stock falls apart then you are screwed. But interesting approach none the less.
Let`s say whole btfly was $50 debit (realistic - I have done it) and this shorts were $45 and once market went down, now they are $25 (also real quotes). Then by buying them back you increase total risk to $100 (two times $25) if the market falls down and never comes back through the life of options. But usually it comes back and advances even higher. Then when you sell them back, let`s say for $45 (again) a piece, you get free trade (minus commissions). Again, this is real simplification of whole idea. But if you open many positions and adjust one at one level and other at different level ? This will give you whole area of similar strategies.
Yeah, I understand what you are doing but the risk is still there. It might not seem significant when its $100 but what if I put on the Butterfly for 25k, then I sell the calls and increase my risk to 50k. Well, 50k is a lot of money and if the stock just drops as much as a couple of points between now and expiration, I lose it all. That is a lot of money. And since I am assuming you are putting these butterflies on the front month, time is not on your side if you get an adverse move, we are talking weeks, maybe days here. I think the better play here is just to hold the butterfly till expiration. In your example, it would be similar to me saying I could buy a call for 50$ and if the stock dropped, buy another call for $50 because the stock will usually come back up. Well, I am risking 100% of my capital here. Sure it's only $100, but 100% is still 100%. Like I said before, on the floor guys could put on long butterflies for credit and a conservative floor trader could make a very good living doing this. He had no risk! However, trying to do these off the floor, you are basically trying to manipulate the position to make it do what you want it to do. I have found over the years with my experience trading options that this is not a very healthy practice. Murphy"s Law always seems to show up at the wrong times. Whenever you need the stock to rally it will sell off, whenever you need it to selloff, it will rally. However, if these are working for you, go at it. Maybe you really have a very good feel for them. Options is all about accepting some sort of risk. If you are willing to accept directional risk, then thats fine. Some guys would rather accept volatility risk or time risk. It's all up to the individual trader.