Skew Flies

The Rationale (The "Why")

Volatility Skew refers to the fact that out-of-the-money (OTM) puts are typically more expensive than OTM calls on the same stock. This is because investors are often more fearful of a market crash than they are optimistic about a rally, so they pay more for downside protection. This scanner identifies stocks where this fear is particularly pronounced, making the "skew" unusually steep.

When puts are exceptionally expensive, it creates an opportunity. This strategy constructs a long put butterfly spread to profit from the eventual collapse of this overpriced volatility. It is a very low-cost, defined-risk bet that the market's implied fear is exaggerated and will normalize over time.

How to Trade It (The "What")

1. This is a long symmetric put butterfly, entered for a short term for a very small debit. You are paying a small amount to establish a position with a potentially massive, asymmetric payoff.

2. Fight for Your Entry Price. This is the most critical aspect of the trade. These flies are designed to be extremely cheap (often just a few cents). Every single penny you pay to enter dramatically changes the risk:reward profile. A trade that costs $0.10 has a much higher potential return than the same trade entered at $0.15. Work your limit orders to get the best possible fill; it is a major factor in this trade's success.

3. Your Maximum Loss is limited to the small debit you paid. If the trade ticket shows 0.12db, your maximum risk is $12 per contract. This allows you to take a shot at a large profit with very little capital at risk.
4. Your Maximum Profit is achieved if the stock price finishes exactly at the middle (short) strike of the butterfly at expiration. It is calculated as the width of the fly's wings minus the tiny debit you paid. A $5-wide fly entered for $0.12 has a maximum potential profit of $4.88 per share ($488 per contract) - but note that this is an impossible goal: the price of the underlying at expiration would have to pin exactly at that body strike. Learn to be satisfied with mere 50-100% returns on risk.
5. The primary goal is to profit from volatility collapse. As the fear in the market subsides, those expensive puts will lose their inflated value, thus increasing the value of your spread. These trades typically return a 50-100% profit well before expiration (again, it takes working those limit orders hard.) If not, and the price remains close to the body strike, they are usually held until 1-2 hours before the close - that's when the BIG theta decay comes into play. If the price blows completely past the fly in either direction at any time, they're usually closed to recover a part of the cost.