what is the problem of butterfly strategy ?

Discussion in 'Options' started by hermit_trader, Dec 10, 2005.

  1. nitro


    I agree, but I think you are only looking at one side of the coin. A real good trader may be able to ascertain overall direction very well, but may not be able to withstand the local volatility of an outright position that often will force her out prematurely, or the premium risk of being long an option (long volatility) in dull environments. The other side is always risk.

    On the other hand, when the underlying moves, being long options is great because the decay of holding long options positions is negligible and you still have a chance to get the overall direction right.

    I am a big fan of simple OTM SIF options. I like to start out long an OTM option with at least 40 days of time premium. Then as the position moves in my direction, I like to hedge it (and turn it into a volatility position) by adding short a farther out strike (verticals) based on simple TA. Once I have the spread on, it allows me to hold a position for weeks/months and being able to withstand both directional risk (by being long options) and the premium risk (by selling a farther out option against my long.) I can also remove a leg temporarily when I want to try to pick tops and bottoms and/or turning points, or change in volatily conditions. Obviously this will only work when the underlying is moving, or you are trading near the turning points in a decent range bound market. Beware of summer markets.

    When the underlying doesn't move my way and the time to expiration is such that theta starts to get steep, I reevaluate.

    But you are 100% correct imo. The retail trader must get either the direction correctly, or be able to predict the realized volatity correctly in the case where he is considering putting on spreads with directional bias. If you are willing to hold to expiration or close to it, flies are nearly a perfect position. It is well known that volatility is much easier to predict than direction, that is why many will look for discrepancies there and put on volatility positions on, instead of trying to figure out where the market will go many weeks/months out.

    Your analogy with sports betting books is excellent.

    #21     Dec 11, 2005
  2. There is a lot of erroneous info on this thread; I don't know where to start. The disdain for flies is great news, as I don't need the competition nor the vol-bleed from body-sales.

    What's not to like? 5 or 6:1 reward/risk on a 30d fly with very low greek magnitude across the curve. Trimodal greeks makes for many trading opportunities when atm or otm.

    The slippage argument is a red herring -- flies are often executed as a single order with a nominal bid/offer. Those of you executing 3-legs are probable churning butter at home while feeding a wood stove.

    Pros have made more money in flies than any other methodology. There are good reasons why many local and upstairs pros trade flies as the primary position.

    That's all I will add to the subject. Haters, keep hatin'
    #22     Dec 11, 2005
  3. lol, a whopping 5/100 of a gamma. Of course gamma peaks at the body strike, but so does the running PnL. A fly traded to expiration that's pinned to the body strike is going to offer large gains for the buyer if held for more than a few days. It doesn't take any modeling to realize the atm options are loaded with gamma, but also theta as well. The only trade that earns more during expiration week, under a less than representative-vol, would be the short neutral straddle.

    Near-term[<30d] flies are limited in vega and primarily a gamma-trade; hence the mag of gamma+theta. It's a play on kurtosis, and a very forgiving one at that.

    Take the diametric position: closing-out the short fly is best done YESTERDAY. The thing goes parabolic at expiraton if trading near the body strike as in Nitro's example.

    The weekend decay into expiration week is roughly 3:1 in a neutral straddle[over]fly, but the fly can be traded 10x larger on an equal dollar/gamma/vega basis.

    Bye guys.
    #23     Dec 11, 2005
  4. nitro


    The RR ratios are meaningless unless an expectancy chart is also given. Otherwise, why not put an infinite number of flies on?

    The legging into flies argument is false I agree. But it is the expentancy analogy that is made with sports betting of "complex" multi-legged positions which is right on.

    That may or may not be a function of only the fly being a superior position. It could equally likely be that premising very deep pockets, very good comission structures, i.e., you work for a firm, that flies are the perfect strategy. But for the retail trader with a very finite account that needs to make money from month to month and not blow out taking the risk to do so, it may be at best an average strategy. Note that I am not suggesting that they are, only that the context of the needs of the trader and his profile are not in vacuum.

    #24     Dec 11, 2005
  5. Quote from nitro:

    The RR ratios are meaningless unless an expentancy chart is also given. Otherwise, why not put an infinite number of flies on?

    Relative to other positions. The expectancy "chart" is meaningless, unless you're assuming the execution edge is dramatically-inferior, which I know to be untrue.

    Uhh... no. Nobody stated the expectancy was positive under any locale in the distribution. I clearly stated that they can be trade larger in contract # due to their relative greek magnitude. Don't they teach this stuff at Last Atlantis?

    Take a look at the atm vertical. It's less than a 50% proposition.

    I have a question for you: Is your equity/futures trading positive expectancy? If not, I think you know where I am leading with the question.
    #25     Dec 11, 2005
  6. To quickly summarize why flies are unique: they're long upside and short downside gamma with an excellent r/r relative to positions with similar greek exposure/risks. Greek magnitude is very mild and suited to risk-averse short gamma/vol traders.

    No other position structures long upside/short downside gamma, including other permutations; condors, etc... Relatively meaningless once booked, but offers a ton of opportunities for gamma traders buying wings and selling body strikes.
    #26     Dec 11, 2005
  7. To clear my question:

    I know if I only bet on a directional trend of the market, then a simple call or put will do. But if I am predicting that the market will trade in a narrow range then I may need to use a butterfly. The unlimited risks of short straddle/strangle scare me!

    Is it generally correct?
    #27     Dec 12, 2005
  8. nitro


    Not necessarily. If you know how to gamma trade, and are very disciplined, you can short "Asian" straddles and hedge with underlying at key points. The problem with them is that they are margin intensive since you have to short three consecutive puts and sell three consecutive calls and always have some underlying that will approximately equal your initial premium+

    If you want a directional bias added to that strategy, you can use some method where you add more to the hedge as the position moves in a given direction, using money management.

    None of this is an edge. However, if you are good at predicting direction and/or volatility, options offer and great place to put on very flexible positions that are multidimensional.

    #28     Dec 12, 2005
  9. cnms2


    What is an Asian straddle? There's an article about it in the last issue of the Futures Magazine, but I am not a subscriber.
    #29     Dec 12, 2005
  10. I had one once at a massage parlor in AC, NJ. You'll want to look to page 40 in the Dec "futures" mag for a description of the option position.

    http://www.futuresmag.com/library/contents.html ctrl-f for asian straddle
    #30     Dec 12, 2005