I've been testing calendars vs. butterflies, and I find that calendars offer slightly better risk/reward, but lower probability. I'm using MSFT, comparing a July Call butterfly (29/33/37) vs. PUT Calendar (sell 33 July, buy 33 Aug). Is my observation true across the board, or is it related to another factor that it particular to this trade? Does anyone combine butterflies & calendars with the same short strike?
Calendars and butterflies both provide means to target a price range. I believe that calendars are long vega and butterflies are typically short vega or low vega. So if volatility is already peaking, a butterfly may be better. If volatility is still low and expected to rise (usually by a fall in the market), calendars may be better.
Atticus has a lot of posts on the subject and it's best to spend some time searching for them. One of his ideas was that if you have a target price X lower than the current spot then you buy a calendar in order to have extra profit from the rise in vol. If X is higher than current spot then spot rising can result in some volatility drop (depending on the correlation of spot with vol) and then being short vega can bring extra profit. There is a lot of other stuff discussed and a lot of trades posted real-time
I understand that differences in how a calendar vs. butterfly react to changes in vega (volatility), but my primary concern is keeping the underlying within my break evens. I'm using a strategy where I can get at least 66.6% probability (I assume based on IV), that the underlying will stay within my break evens, and I'm having a hard time getting to this number using calendar spreads alone. My target price is not a specific strike, but within a range of strikes. In the case of MSFT, I get a break even range from $32.20 - $36.02 when using a double calendar (33 PUTS and 35 CALLS). I'll play around with using the calendar on the down side and butterfly on the upside and see if that gives my wider break evens.
My understanding âand someone correct me if itâs not right- was that for index under the assumption of high skew and sticky delta, the back leg of the calendar will not make as much vega profit or even lose on vega. Eg you enter the (calendar) position at spot = 100 and buy a 90 put. You âoverpayâ because of skew. You are correct and the price drops at 90. Now strike 90 is ATM so the sticky delta will hurt the PNL. Obviously it depends how close is the approximation to sticky delta.
It's somewhere in between sticky strike and sticky delta for indexes. Most of the time it's behaves as sticky strike. Anyway, you buy back month where skew is less negative than front month. Vols rise with the market falling - how would you lose on vega? No it's hard to lose on vega being long put. You may lose on short vega in front month more than you gain on a long vega leg, that seems a more likely way to lose on an otm put calendar.
I believe atticus was referring to his own trades as documented in one of his journals, not in general.
From what I understand (and Atticus and others please correct me if I am wrong), the reason is due to index skew and sticky delta. Sticky delta is the phenomenon where the entire skew curve moves with the spot price, such that a strike with the same delta will have the same implied volatility. An upside index butterfly will trade at a premium to the value under a flat volatility skew assumption, while a downside index fly will trade at a discount to it. All other things being equal, a flat skew curve is critical to the success of a fly. This essentially means that you are overpaying for an upside index fly, and underpaying for a downside index fly. E.g. if you purchase an upside SPX fly, and the spot price subsequently moves up to the body strike, then the body strike will have gained in implied volatility and hurt you. If you purchase a downside SPX fly, and the spot subsequently moves to the body strike, then the body strike will have lost implied volatility and will help you. The body strike really drives the fly value. If you buy an upside index calendar and the spot price subsequently moves to the strike, then the implied volatility of the spread will rise helping you. If you buy a downside index calendar and the spot price subsequently moves to the strike, then the implied volatility of the spread will fall hurting you. Since stocks obviously have a different skew curve than indexes, the opposite trading approach is generally the correct one for stocks. I credit Atticus for learning about this as he has spoken about this quite a bit in his journals and elsewhere on the site.