Posted here is a live trade example of a LULU iron fly. I started this out as an earnings trade iron condor, looking for classic volatility contraction post-announcement. I got the contraction I wanted, but not the movement, as price immediately broke the short call side of my setup, after which I rolled to an iron fly. (See Post Below). A week after earnings, price has dipped, skewing the net delta of the setup long.* Currently, the net delta of the setup is 24.92, with the respective strikes having the following delta/dollar values:
57.5 Long Put -11.05 delta/46.50
70 Short Put 65.10 delta/522.50
70 Short Call -34.92/170.00
80 Long Call 16.14/19.50
What, if anything, should I do to "defend" the short put side of the setup? Here are my options, with pros and cons for each:
1. Do nothing. There is, after all, plenty of time** until expiry and "fiddling" with the setup here may unnecessarily complicate exiting the trade and potentially increase risk if I choose, for example, to erect a defensive hedge or roll the short call side down toward current price. Additionally, the setup isn't "hugely" out of skew yet and price remains above my break even for the short put side of the setup.
2. Roll the short call or short call side toward current price in the same expiry. This would add short delta to the setup. Personally, the only time I want to take a straddle and roll into an "inverted strangle" is when the short option is approaching worthless and basically providing little to no protection to the oppositional side. That isn't the case here yet: the short call is at the 35 delta or so and is still worth $170.00.
3. Erect a defensive hedge. In this particular case, the setup is net delta long, so I would look to add short delta to the setup, either with a naked short call or a short call vertical. Generally speaking, I like to erect hedges that are, in themselves, high probability setups, so in all likelihood I would sell the 20 delta short call or as close as I can get to it or erect a short call vert with the short leg at the 20 delta strike, and the long leg above it. The Jan 20th 72.5 short call is worth 24 short delta, so that would just about do the trick to get the setup back to almost completely delta neutral. Alternatively, the 72.5/77.5 would add in -14 delta and bring in .70 in credit to boot.
Unfortunately, this adds risk to the setup, namely that price will retrace to the call side, thus amplifying short delta, because I would now basically have two short delta or bearish spreads on (the 72.5/77.5 and the 70/80).
* * *
My basic approach is to stay mechanical. If the untested side isn't approaching worthless, simply leave the setup alone, as temporarily painful as that may be. One side or the other of an iron fly, after all, is being constantly tested, as there is practically no way that price will stay at your short straddle for any length of time.
Only when the untested side is approaching worthless do I look at what can be done, with my first preference being to roll the untested side toward current price. This results in a "goofy" setup (an inverted short strangle), but it also means that I'm not taking on additional risk as I would with a hedge.
If rolling the untested side would simply be unproductive (there is too little time to expiry to get anything for the roll, for example), I then look at a purely defensive hedge either in the setup's current expiry (again, if that is productive credit-wise) or, if necessary, further out in time.
* -- As price moves toward the put side of the setup, delta "lengthens" or becomes more net positive; as it moves to the call side, it "shortens" or becomes more net negative.
** -- "Plenty of time" is somewhat subjective here and will depend on what's happening with the setup.
57.5 Long Put -11.05 delta/46.50
70 Short Put 65.10 delta/522.50
70 Short Call -34.92/170.00
80 Long Call 16.14/19.50
What, if anything, should I do to "defend" the short put side of the setup? Here are my options, with pros and cons for each:
1. Do nothing. There is, after all, plenty of time** until expiry and "fiddling" with the setup here may unnecessarily complicate exiting the trade and potentially increase risk if I choose, for example, to erect a defensive hedge or roll the short call side down toward current price. Additionally, the setup isn't "hugely" out of skew yet and price remains above my break even for the short put side of the setup.
2. Roll the short call or short call side toward current price in the same expiry. This would add short delta to the setup. Personally, the only time I want to take a straddle and roll into an "inverted strangle" is when the short option is approaching worthless and basically providing little to no protection to the oppositional side. That isn't the case here yet: the short call is at the 35 delta or so and is still worth $170.00.
3. Erect a defensive hedge. In this particular case, the setup is net delta long, so I would look to add short delta to the setup, either with a naked short call or a short call vertical. Generally speaking, I like to erect hedges that are, in themselves, high probability setups, so in all likelihood I would sell the 20 delta short call or as close as I can get to it or erect a short call vert with the short leg at the 20 delta strike, and the long leg above it. The Jan 20th 72.5 short call is worth 24 short delta, so that would just about do the trick to get the setup back to almost completely delta neutral. Alternatively, the 72.5/77.5 would add in -14 delta and bring in .70 in credit to boot.
Unfortunately, this adds risk to the setup, namely that price will retrace to the call side, thus amplifying short delta, because I would now basically have two short delta or bearish spreads on (the 72.5/77.5 and the 70/80).
* * *
My basic approach is to stay mechanical. If the untested side isn't approaching worthless, simply leave the setup alone, as temporarily painful as that may be. One side or the other of an iron fly, after all, is being constantly tested, as there is practically no way that price will stay at your short straddle for any length of time.
Only when the untested side is approaching worthless do I look at what can be done, with my first preference being to roll the untested side toward current price. This results in a "goofy" setup (an inverted short strangle), but it also means that I'm not taking on additional risk as I would with a hedge.
If rolling the untested side would simply be unproductive (there is too little time to expiry to get anything for the roll, for example), I then look at a purely defensive hedge either in the setup's current expiry (again, if that is productive credit-wise) or, if necessary, further out in time.
* -- As price moves toward the put side of the setup, delta "lengthens" or becomes more net positive; as it moves to the call side, it "shortens" or becomes more net negative.
** -- "Plenty of time" is somewhat subjective here and will depend on what's happening with the setup.
