The more I trade the fly, the more I’m trying to understand the importance of selection. 1. Strikes (body vs wing) 2. Width (length of wings from body) 3. Skew (lopsided upper/lower wing) 4. Moneyness (ITM/ATM/OTM) 5. DTE (choose the weekly or monthly cycle?) 6. Vola (which IV to buy/sell) I’m pricing other spreads in $ZM and realizing other fixtures of flies are gaining more in premium vs my fly.
@.sigma, isn't the 4.) Moneyness already covered by the first 3 points? Once you've decided which strike to put the body on, and what width to use for the wings, then you're already chosen the ITM/ATM/OTM route. Similarly for 6.) Vola. Wouldn't the vola help decide the body/wing strikes? For me, moneyness/DTE/vola are the key components which help to choose the secondary factors of strikes/width/skew. My moneyness is influenced by a view of the range where the underlying is going to trade in the near future. For example, I believe (rightly or wrongly) that the SPX will not breach the 3800 mark in the next 2-5 days, so yesterday I opened the 15-Jan 3650/3725/3800 iron. From memory, I think my upper B/E is around 3780 or around there. On the downside, I'm safe for a couple of hundred points drop in the SPX. Now it's a case of the vola dropping a point or two, and theta doing what theta does. If the SPX drops and vol rises, then delta comes to my rescue. The threat to the trade is a rise in the index.
I'm starting to price straddles on a few underlying's then pricing the fly relative to it. My heuristic method is a continuous process and I'm getting a "feel" for how premium is sucked and pumped out of and into options. The value of the straddle determines the premium for the fly (synthetic iron). ATM flies have a linear relationship with vola and a square root relationship compared to DTE. Compare an ATM butterfly to vola and notice the relationship is linear. and a square root relationship compared to DTE. The value of the straddle is the determinant factor. Of course, right? The volatility will create the distribution. "Normal" volatility and ATM fly is delta neutral. But notice the higher vola gets, an uneven delta distribution causes the ATM fly to be skewed to the downside. This skew needs to be accounted for. I'm trying to figure out what strikes/expiration gives the most bang for a buck. ATM 10-width? OTM 5-width? ATM broken-wing 2/1? OTM ratio 30-width? I don't know. But I will be pricing lots of flies this year and studying how the premium moves throughout the duration of its life, in comparison to spot..
"The implied volatility of an option is usually compared against historical volatility to see if it is cheap or not. However, while there is only one implied volatility, there are many different measures of historical volatility." This quote above... only one implied vol? I don't think so... Maybe the author means theres only "one way" of measuring implied vol? Because every security I look at has NUMEROUS implied volatility numbers. On thinkorswim, pick a ticker and scroll down to "Todays Option Statistics" They give you the implied volatility for the ticker... but then you have implied volatility figure in each expiration, and even each strike. So my question to anyone reading this, is what implied volatility number do you look at (or which one matters most?). I'm assuming its the plain IV number of the overall underlying mentioned above?