Bearish butterfly - what am I missing?

M

Michael B

Member
David Thomas presented a bearish butterfly on the RUT few weeks ago (Trading Group 1 - June 14, 2021).
He said that the RUT had a long run up and the butterfly made sense plus it was pretty cheap (around $5).

Looks good at first sight, but ...
After the long run up IV was low, so it also made sense to expect it to increase in case RUT would turn down. Increasing IV would hurt the butterfly. In fact no matter where IV is at the moment, the fly is Vega negative so any IV increase is not good for it.

At least this is how I see it. Wrong?
 
Mike I didn't watch TG1 you mentioned so can't comment on that.
In general what you said is correct. In general putting bearish trades after long up-run makes sense. It enen can be BF if one insists.
Devil is in details.
You can put bearish fly and you can do it in a good, bad or ugly way. Spikes in IV do harm BFs but, in my opinion , managing a trade is more important than attempting perfect entry.
Anyway, what is missing in your analysis is time factor. BF in different dtes have different characteristics.
 
In a John Locke style BB Your T+0 line should be negative Delta to start the trade and your lower puts will dramatically increase in price if you have a major increase in volatility and you would make money.
 
A bearish butterfly is, by definition, placed below the market and will gain in value as the market moves toward the butterfly even as volatility increases.
 
Andrew, not necessary.
Here is an example of 30dte, 10pw regular BF.
It was put with "green skew" - atm IV ~9
when IV rises to ~14 atm this rBF is underwater at any strike.

On top section you see Vol skews on the bottom one - t-0 lines and part of trade expirations graph.

1625789856200.png
 
I did not show the details of that fly because I thought most of you watched that video.
Seeing I was wrong about that, here they are: symmetric fly 2260/2310/2360 for around $5 debit. RUT was 2330 or so.
 
IMHO, out of the money PUTS are generally trading at higher IV versus the ATM,so with all the moving parts considered (the 3 strikes Long-short-long) generally speaking the Butterfly p&l will suffer .That's the reason why they are starting with a negative delta.
 
I see it as 2 separate things that work together
Yes when SPX goes lower IV increases which hurts the trade overall but when you look at the T+0 line it will make more profit as it moves closer to the sweet spot which is somewhere past the lower long
As long as it does not continue to go lower you could take profits there or maybe wait another day for a bounce which will lower the IV and make it even more profitable
 
i'm not defending the trade, but there are a few things i remember about the bearish butterfly. the downside adjustment is to roll down the butterfly. when you roll down, you generally buy a cheaper
butterfly. i modeled a butterfly and adjusted it down 30 points. i set the original strikes to be about 20 points out of the money, like you specified. you didn't specify the dte so i just used the aug expiration
(42 dte). the original butterfly was $5.9 and the adjusted one is $5.0. ignore the thin blue line, but the
thin green line is the aug iv curve. you can see you're rolling down to a higher volatility. one saying that
tom sosnoff uses all the time is that when skew is high, puts are expensive and put spreads are cheap. the skew right now isn't very steep, but will steepen if the market drops.

in the picture below, the original butterfly is magenta, the adjusted butterfly is blue.

1625849353713.png
 
I would not even try to adjust it by adding another butterfly lower I would just take whatever the profit is at the peak of the T+0 line and maybe open a new one lower with further out or same expiration as the original I would only add it to the upside if it goes up as per the rules
 
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