Butterfly Option Strategy

The Implied Volatility (IV) of Calls needs separate treatment from the IV of Puts. Also, for specific options trading strategies treat the IV of both Puts and Calls as a combined bundle.Each option at each strike implies its own individual percentage value of the underlying product’s future volatility. This makes it unique from any other option within the same chain of a given expiry month. The individuality of an option’s percentage value at each strike is what draws the “smile” in the IV’s Skew.So, while an ITM Call has a corresponding OTM Put sharing the same strike, conversely an ITM Put has an OTM Call counterpart at the same strike, the Call must be treated uniquely as a Call and the Put uniquely as a Put. The more ITM an option becomes, its intrinsic value becomes higher and its extrinsic value is lowered. Conversely, at the same strikes where an ITM Call (or Put) gets deeper In The Money, the corresponding Put (or Call) becomes further OTM. The more OTM an option becomes, its extrinsic value rises higher and its intrinsic value is lowered. Even with ATM options, where the Call’s Delta is exactly 0.50 and the Put also has a Delta of exactly 0.50, the Implied Volatility on either side of that same ATM strike is different.While Calls and Puts appear side-by-side for a given strike, they are not identical twins to simply trade places. Think of it this way, each option has its own Intrinsic-Extrinsic fingerprint that makes that Call or Put identifiable only to itself.The logic for treating the Implied Volatility of Calls separate from the IV of Puts becomes obvious in the construction of specific spread types. Let’s break down the components making up the following spreads.

Now, let’s compare the above spreads with these other types of spreads.

Clearly, there are more spreads that require the Implied Volatility to be differentiated between Calls versus Puts, compared to the use of a combined IV. So, in choosing a data provider of Implied Volatility, make sure you get the IV data of Calls that is set apart from the IV of Puts; as well as, data that combines the IV of Calls and Puts together. That means 3 sets of IV data in one service.We have just established the structural logic for decoupling the IV of Calls from the IV of Puts. How do you apply this to a trade? Here’s how.

Is there a working example of a consistently profitable portfolio that treats Implied Volatility of Calls separate from the IV of Puts? Yes. Follow the link below, entitled “Consistent Results” to see a model retail option trader’s portfolio that applies this logic.To conclude, I’ll use an analogy. Though an egg comes in one shell, the yolk is separated from the white, for a different purpose that distinguishes the individual parts of that same egg. Treat Implied Volatility of an option’s anatomy in the same way.