Forums  > General  > Butterfly’s & Term Structure  
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Total Posts: 1
Joined: Jul 2020
Posted: 2020-07-17 12:47
The other day Chris Cole, who runs the hedge fund Artemis Capital Mangement, tweeted a graph comparing previous election cycles via volatility. Basically the TS is forecasting a much higher chaotic election year compared to previous.

My focus is more about the topic of trading or price gauging the term structure using butterfly spreads. I have never done this, although I do trade butterflies all the time. I only trade flys in single name equity, though. Always in the same expiration and same underlying. But I’ve never bought +1 August, sold -2 September, bought +1 October before. What’s your thoughts on this? Does anyone here trade or have traded term structures with flys? Has anyone used this to price skew?

For example the infamous risk reversal is a optionality financial savvy peeps use to gauge skew in the indexes, but I’m finding out you can also use butterfly’s to accomplish the same thing, or similar. Anyway this is my first post/thread (long term lurker) hello all!


Total Posts: 591
Joined: May 2006
Posted: 2020-07-21 12:30
The concept of butterflies actually came from the yild curve - and there it was just about the term structure, nothing else.

That trade seems to be all priced in though. Markets tend to be volatile in election years? Duh.

"There is a SIX am?" -- Arthur


Total Posts: 2
Joined: Aug 2014
Posted: 2020-07-21 15:46
The risk-reversal trade can be interpreted as the finite-difference approximation to the first derivative of the price of OTM options with respect to the strike: (P(x+h)-P(x-h)) / (2h). So it is long Call, short Put. The calendar spread is first derivative of the price with respect to time. When you put on a trade, if you do not divide by h, the risk of the trade should very very roughly be proportional to 2h assuming that the slope has constant volatility (which it general won't).

The butterfly trade is the finite-difference approximation to the second derivative: (P(x+h)-2P(x)+P(x-h)) / h^2. The exposure to the curvature factor would be proportional to h^2. But another reason to trade the butterfly other than getting exposure to the curvature is that it is neutral to the slope and the level, it can be used to isolate event-specific risk. But beware: VIX futures should have some "natural" curvature on their own even in the absence of event-specific risk.
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