All, I'd like to start a thread on trading iron butterflies on the SPX for income. In the interest of learning, I will detail below a trade that I did today. As I am putting this out in the public domain, I will hold myself accountable for it's management. Pls feel free to critique, critcise and advice. All constructive feedback is welcome. Here goes: Date : Fri 14-Jun Trade : Iron butterfly; short put spread being 2850-2900; short calls spread 2900-2950 SPX : 2885 at time of trade open VIX : 15.7 Expiry : 05-Jul (21 DTE) Credit received : 38.90 Greeks : theta is around 23, and Vega around -75. So by Monday alone, the theta will give a small profit. Any increase in volatility will hurt. The P/L graph at time of open looks like this : The rational being that within about a week (depending on the SPX level), I will close for a small profit (say 5-10%). Of course, a week is a long time, and anything can happen. And that is what brings me to this forum. I will try and adjust as appropriate and would welcome advice/insults/abuse. Okay, not the insults/abuse, but you get the point.
How are you deciding the criteria to enter the trade? It seems stupid to lock yourself into one spread and just sell 21 DTE near the money iron flies. What criteria are you using to decide to enter the trade?
Care to explain a bit more? What would make this trade less stupid? To answer your question - I entered this trade based on two things (1) a sense that the SPX is stabilising after a big rise last week (2) that VIX will stay more or less the same as a result of (1). Sure, I could have gone for a longer DTE, and there are advantages of doing so, in the same way that there are pros and cons of doing a 10 DTE fly. I went for a 21 DTE as it suited my risk tolerance better. -
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What I mean is if you're only trading iron flies for income to the exclusion of all other strategies you're either going to eventually choose the wrong strategy, or make a suboptimal play. The SPX IV percentile is around 19%, so it doesnt make much sense to sell an iron fly into a market where IV is expected to expand. You're going to get creamed on vega. If the expansion is bad (perhaps if Trump opens his mouth on Sunday), vega could outpace any gain you'll see from theta. The reason I ask why you made the decision is exactly that - you can't just harvest premium in an environment where IV can expand. You need to wait for people to start panicking. The market in general appears to be fairly low IV percentile (when markets march upwards that's what happens), so it's a debit spread player's game right now in order to capitalize on the likelihood of market wide volatility expansion which will likely help make up for negative theta.. I'd be interested in your reasoning for selling a credit spread into that market. Additionally, I wanted to know what your signal for this trade was.
Sounds way too vague to be successful long-term. What's your vol forecast and why? What is your reason for thinking spot will still be pathing around 2900 in a week's time? What are some hard metrics that will invalidate your thesis? Theta won't "make you a small profit" by Monday no matter what. What if we gap down a few percent? Now you're paying theta to keep your position on. Even if spot doesn't move and vol swells, now you're marked to market for a loss. Where's the theta you're talking about? I'd hit the books if I were you. Options and the fallacy of thinking you can derive income from them selling blindly has been beaten to death in the past on ET. Read the SPX credit thread and maybe the a chunk of the post history of Maverick74, maybe that will give you a more realistic idea of how you should be approaching options if you want to succeed in the long haul.
Thanks gaussian for a very useful response. You make valid points. Firstly, I did not state anywhere in my original post that I am using only iron flies for income to the exclusion of the other strategies. (This thread will just be about iron flies.) Apologies for the misunderstanding. The SPX IV being around 19% is an interesting point. I do not use Think or Swim (I'm UK based and we did not have access to ToS a couple of years ago), and I am using IB, and to my knowledge the IV Rank info is not readily available there. I'm using VIX as a crude proxy. Ideally, I would like to open this trade when VIX is higher, but felt the need to try this with a small allocation to gain hands-on experience in managing this type of trade. "you can't just harvest premium in an environment where IV can expand" Totally agree. IV expansion will hurt. However, my personal feeling is that (barring Trump opening his mouth on Sunday) that the SPX is looking to consolidate. Even just 3-5 days would be sufficient to enable me to close out of the trade profitably.
^^^ This. I think 2850 is a fair price for the SPX to cusp -- implying that at 2880, we're a tad high for a short-term number. (If it helps, think of 2850 as a pendulum perigee, and we're then 1% above perigee, having just finished a swing from the bottom-side right up to 2900. ) Implication? Just as gaussian wrote, the *most*likely* direction in a Mean Reversion world, is down in price, and up in volatility. The Theta you cite is sweet, but the vega gaussian cites is bitterrrrrr bitter bitter bitter. I happened to list out some Badness Triggers this morning -- there was one economic: the FED meeting (and the over-hyped likelihood of a rate decline). That's bad enough, but there were a truckload of NON-market triggers: China/tariffs; NK/Lil' Kim's letter; Oman/Iran; Mexico/immigration; Drumpf/foreign_aid_of_an_electoral_kind -- get two or three of those FIVE firing at once? We're down kissing 2650 again, quicker'n snot.
The fella's [gaussian & Tom] beat me to it. U.S. Market Participants are likely leaning way bullish right now having already discounted into price multiple FOMC activities... as in at least 2 rate cuts, and perhaps as many as 4. Overall market I.V. is low, and what do we know about low Vol? Low Vol leads to high Vol...especially when there are several highly visible catalysts steering us right in the face. The nearest (visible) catalyst is the Fed meeting coming up this week. And we know that regardless of what the Fed does or does not do, there will be some large fraction of participants on the wrong side of price as they must be...by definition. Positive Theta is good and all, but -Vega will rip yer face off due to convexity thereby negating any time decay. Rather than systematically putting on any structure to the exclusion of other market-based conditions...model your Vol Line first. Only then begin to estimate all other conditions that may or may not exist. At least then you'll be in a position to understand what structure(s) fit(s) your estimation. personally, I think we'll drift higher into the Fed announcement. Then, I see no realistic scenario in which we trade higher in the immediate days after the Fed...and of course, Vol goes higher too. If I'm right then you'll get your shot to layer in some flys. G/L
There are people who make income from option spreads. You should watch some of the Dan Sheridan options you tube channel videos. He discusses when to use various types of spreads such as calendar spreads. Sheridan is trying to sell his advisory service, but his free videos on his web site and you tube are good. I think his view that it is hard to predict the market is good. Also, I do not think VIX around 16 is low.