You dont convert the spread into a FLY, you conver the short strike into a long fly by buying the wings and selling the long side of the spread. The sale of the long side partially offsets the cost of the wings and you lock in a smaller loss- DEPENDING on the option prices at the time. You take the smaller loss than closing the spread outright, remove the margin requirement and the long FLY can run to expiration for the potential for profits to reduce the loss somewhat or make enough to turn it into a profit. For example, buy the 1350 and 1360 ES wings, sell the EW 1375 Call for a small net debit. It is one type of adjustment to take a smaller loss and still have a chance isntead of closing out the entire spread and locking in the larger loss. Again, it depends on the prices at the time and you choose the cheaper route (FLY v. closing the entire spread). I am not saying you can always do this, but it is one choice.
I mean if you are short the 1355 Call, you can compare the cost of closing the 1355/1375 spread v. Buying the1350 and 1360 calls to convert short call to a Fly and selling the long 1375 Call. In some cases the FLY exit will involve a smaller loss to get out but you still have the FLY open for potential profits to reduce the loss or in a very small chance, turn the whole position profitable if it is back at the short strike at expiration.
How 1350 + 1360 calls minus 1375 calls can be purchased for a small debit ? I am probably confusing ES with EW , I will look at their prices tomorrow. Phil , I hope spx will tank and you don't have to go thru any adjustments , but if opposite is the case , I like to see/learn how you will do it. As I already stated once on this thread , I view every adjustment as a new , stand alone trade with it's own odds and probs.
Thanks for the clarify OC. I do agree with you that flying the short call vertical would limit the loss somewhat but to expect a profit even a modest one at that is wishful thinking at best. We all know a fly has a very narrow profit peak. What I've found from real life experience trading them on the floor vs. on the screen is that not only is the profit window small but the peak itself is much less if you do get lucky enough to guess the sweet spot at expiration. The vig, the commish, execution risk when you leg in/out of the spreads all seem to work into tamping down that profit peak. Maybe you have far superior execution skills than I but bid/ask vig is pretty hard to overcome on a 3 way spread by anyone unless you are willing to assume some form of greek risk in the interim. This is why the payoff of a real life fly put on at fair value is usually inferior vis-a-vis the same fly when you model it on a simulator. Some guys here , Riskarb comes into mind , alters the payoff in his favor by taking on some greek risk. To have a point that you can put on a directional spread, have it go against you, repair it by putting on a fly and expecting it to make some profit when a fly at fair value only has marginal profitability is asking too much from the trading gods. In such as scenario, as Mav pointed out, you'd be locking in a loss except for maybe 5% of the price distribution chart. Nothing wrong with limiting the bleeding thru the fly, but to expect profit in a long string of trades in this scenario just ain't happening.
The question is whether it can be purchased for a smaller debit than to close the actual diagonal. It depends on time value premium of course. And the 1375 in this case would be the EW and the 1350/1360s would be the ES. I must repeat again, this was one of a few possible adjustments over closing out the spread and I am not saying that you simply do this and all losses dissappear. It is an adjustment to consider at the appropriate time. And I do not need SPX to tank lol, I just feel we are extended and due for a pullback. I am not saying we will crash or that the bull run is over as some have interpreted my statements. My window is the next three weeks only. We will see...
I think you are putting too much emphasis on the profit discussion of the FLY adjustment I mentioned. I said that if possible I could conver the short to the FLY and close the long for a smaller loss. Once I do that I am out of the trade, but I still have a long FLY sitting there. The point I made is that you simply ignore it and move on. However, there is the chance that the FLY could have value at expiration. it does not matter if it is highly unlikely, I have already adjusted out of the trade and taken my loss and moved on. The entire zone between the wings is gravy premium if the market should happen to fall there at expiration since any premium you can recover reduces the loss, even if just a little. The FLY is just sitting there and if it expires worthless, you already accounted for it in the adjustment to get out. If by some miracle the market ends up at 1355 at expiration, then the spread is worth about $5 (slippage) and a huge overall profit. Is it likely? No. Does it matter? No. the FLY was a means to exit the original position. However it still exists until expiration as a potential huge payoff. Again I must reiterate that I never said the adjustment will turn the loser into a winner. It was a MEANS for an EXIT at a lesser loss than closing the spread outright. I have no EXPECTATIONS from the FLY. However I will not ignore the tiny chance that it could bring in premium at expiration. I never said I expect it or guarantee it, but there is no reason to ignore it completely and not account for it as a lottery ticket you receive when exiting the losing position. You are looking at the FLY as a new position, I am looking at it as the EXIT of a position. If it expires worthless, then I am right at the expectation I had when I exited the position to begin with. if it makes some money, then I got very lucky and I am not going to turn down the profits. I agree with everything you say about FLYs. But tis FLY was no entered into with the expectation of a payout. It was a way to cut my losses if possible on the exit.
Phil, I think that Fly will cost you a king's ransom to put on. The EW 1375 call you are selling will have very little value on it yet the 1350 and 1360 calls will cost a fortune to buy if you are doing this if the ES is at 1355. Phil, this could be like a 100k debit we are talking about here. And you are risking that debit on the fly. Am I missing something here? When exactly are you going to put this fly on? This fly is way too expensive to purchase, way too much risk.
I fully understand your point about using it to exit. I've done it many times myself. But in that scenario you described wherein you are using it to exit a credit OTM call spread that went ITM, you will find that if you plug in realistic prices you would be buying strike A and C for and selling strikes B, D to convert it into a fly, you' d end up paying $3.50 -$4.50 for that $5 fly. I am not questioning your logic ,it is very sound, just the "back of the envelope" math that you do when you say that you'd repair it and maybe lose a little, or make some as well.
Well yes I wish I had a real example to lay out the prices but I have only been testing it out in general. In the previous spread I noticed instances where the cost to purchase the FLY and sell the long call resulted in a smaller net debit than closing out the spread itself. It is only viable for consideration when closer to expiration when there is less time value premium. I appreciate your input and comments and welcome to the thread!