Option traders, at Option Pit we tell our option mentoring students that it is important to understand how skew make a trade more or less favorable. One point we make is that butterfly's perform better when the upside skew is steep and the downside skew is flat. The basic concept of this is that it gives us more hidden delta from the puts, and less fake delta from the upside calls. Yesterday, I mentioned in the blog that skew looked really bad for a butterfly. I thought it would be interesting to analyze what would have hurt a 5-lot delta neutral 1075-1125-1175 butterfly. Here is what the fly would look like after flattening the delta with 2 1160 calls and 2 1010 insurance puts.
The Greeks were:
-10 delta, -1.48 gamma, +40.71 theta, -130 Vega
We posted yesterday that the skews were:
ATM IV was 19.95
Put Skew was 142% (vol of 28.4)
Call Skew was 90% (vol of 17.95)
Obviously, the underlying moved up 23 points today. The position is allegedly short vega, and the VIX was in over 2 points today. Based on the position greeks, the position would have lost 230.00 from delta, and another 400 dollars from the change in delta caused by gamma. This would be a loss of 730 dollars. However, with the VIX in 2 points, the position should have made back over 260 dollars from vega and another 40 dollars, if you want to add Sat and Sun it would be another 80.00. Thus, net the position would be down about 300.00 dollars.
How did the position actually do? It ended up marking out down a (although that means little) at 3:30 eastern (probably the last time OV6 will give an accurate picture of the prices). The position was losing over 600.00 dollars? In fact there were times this position was down almost 800 dollars. What changed?
Skew! The call and put skew got smoked plain and simple, the IV of every strike got smoked, but in relative terms, the wings lost 1.5%, The ATM's only lost less about .65%. Remember, Vol is not uniform in movement!
Just a reminder, the AM Pit Report is back! Don’t forget to check it out next week. We did enter a SPY fly today during the Mid-day Report and adjusted the DIA fly we had on for the AM Report.
Info from OV6
