Agree Ron... It's a team work. You can explain the concept much better than I can.[/URL]
You were spot on in explaining that shifting the long strike down is a better adjustment if market rallies and the IV skew steepens. I would like to share my thought about the choice between shifting the butterfly short strike up and shifting the right leg down. Both creates positive delta but they are suitable for different scenarios.
1. Shifting the right leg down usually adds negative theta and positive vega (depends on where the right leg is relative to ATM). In normal situation, that's not desirable. But after a sell off and when market is rebounding, the right side of the T+0 will drop and delta becomes negative much sooner than expected due to the steepening of the IV skew. As a result, the adjustment point will likely be well within the tent. If so, the position theta will likely be quite rich and vega quite negative. Therefore, adding some negative theta and positive vega isn't too big a deal. As you nicely explained in the video, the steepening of IV skew will benefit this adjustment.
2. However, in situations when the market has gone through a long rally, while IV will be low and IV skew relatively steep, ATM will likely be on the right side of the tent or even outside the tent. Delta/theta ratio will likely be high and vega approaching neutral to positive. Therefore, we can no longer shift in the right leg as we cannot afford to add any more negative theta nor positive vega to the position. In this scenario, shifting the short strike up is more appropriate because this adjustment will add positive theta and negative vega instead.
Thought I highlight the difference between these two adjustments.
Great summary Kevin.
One comment I have is that rolling the middle shorts forward introduces more downside risk than rolling upper longs in.
So, in the case where IV is very low and the market has been grinding up, the M3 T+0 is relatively more stable even over the upper sea of death because IV can't really go lower and skew can't steepen further. The one caveat of rolling shorts forward in this scenario is that (absent other adjustments) you are introducing more downside risk in the event of a sharp pullback (like we had earlier this September). If you do roll shorts forward, look to manage downside risk by also rolling in lower longs -- especially if that lower roll is super cheap.
