On Sun, 18 Jul 2010 21:13:56 -0700 (PDT), Arthur Schwartz
<comedynight2000@yahoo.com> wrote:
>http://www.btinternet.com/~phalperin/
>
>Above is the link. See the article on Closing a ratio spread; last page; paragraph beginning "Moreover....." where he talks about buying butterflies for a credit.
>
>I was fortunate to meet Phillip in Moscow where he is a risk manager for Alpha Bank, one of the larger banks in Russia. The way he explained it, is somewhat more complex than the article. Take an underlying trading at 100. He buys the 100 ATM straddle; sells the 90-110 (just OTM plus one strike) strangle three times; and waits. His predetermined plan is to buy back the farther out strangle, twice , or at least one side of this double ratio spread, based on time decay or a move in the underlying. for example a modest move up in the underlying allows him to buy the two 85 puts to lock in his put fly at a credit. Then time decay and possibly a drop in the underlying allows him to close the call butterfly by buying the two 115 calls. It is a dynamic trading strategy but only if you are willing to be naked short for a brief time. There are significant risks yet the rewards are also great.....Joel
>
>
I hope you can help me out Joel since I have had similar ideas and
would like to understand what is going on. Do you mean that on a move
up from 100, he goes from a 3:1 90/100 put ratio spread to a 2:3:1
85:90:100 asymmetric fly? I found the description, "buy back the
farther out strangle, twice," confusing. I suppose if the market
keeps going up, he gets killed. By the way, it took me a while to
realize that closing a fly doesn't mean closing out a fly position but
transforming a ratio to a fly.
I read the Halperin article carefully and have some complaints:
1. A more intuitive description, and one that generalizes to
complicated spreads, of how you "close a call ratio to a fly" is: In
order to guarantee the slope to the right of the closing strike is 0,
C + L - S = 0 where these are the respective number of long closing,
original long and short calls. If Kl, Ks, and Kc are the strikes at
the original long, short and closing calls,you guarantee that the
expiration payoff at the closing strike is 0 by,
(Kc - Kl)*L = (Kc - Ks)*S. This formula is equivalent to the one he
gives.
2. I find the key statement he makes unexplained and obscure:
"It was in this manner that I traded from the short side through the
EMS crisis of 1992 in Swissy (USD-CHF), selling volatility at 17% and
buying back at 22% or more, and made money in the process, without
spot hedging. If you continuously follow a process of acquiring long
butterflies at a credit, you will make money. In general, you will
make much of the credit from the short options spread, and every now
and then you will make money from the long inside options as well".
3. The article was copywrited in 1998 as he promised more in the next
installment, including actual applications to the FX and other OTC
markets. I suppose we shouldn't hold our breathes.
I certainly agree that it is nice to get long butterflies at a credit.
The trouble with double ratios, is that you may lose more on the other
portion of the trade while getting a free fly on one side. By the
way, a portfolio of cheap flies can be a money maker, even if most of
them expire worthless. I don't see the need to make them all risk
free.
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