Daily Brief - How to buy the dip and survive

We’re in the most classic investing situation. The market has fallen a lot and one is tempted to play for a rebound. But how can you buy your favourite security/coin with a modicum of safety?

It is important, when catching a falling knife, to ensure that you wear safety gloves of sufficient strength.

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A good structure to play a rebound

Timing a rebound is tricky and the fear of downside colours all investing decisions.

There is no option combination that always makes you money. However, combos of options can help you shift risk in whichever direction sits more comfortably with your risk preferences.

In this spirit, here is a structure that can help you play for a fast rebound in the market. It’s a minimal modification of the standard butterfly and it looks like this:

• Sell the ATM call
• Buy 2x OTM calls
• Sell 1x very-OTM call

With the right strikes you can get this on for $0.00 price, with this payout profile:

Focus on the dotted line, that’s your payout for the first week

The advantages of this skewed butterfly

The advantage of this structure is that you can test the market without fear of a collapse. These scenarios all work well in fact:

• The market drops and never comes back
• The market rallies a small amount, but very fast
• The market rallies quite a lot, even if takes a month

The drawbacks of this skewed butterfly

The weakness of the structure is that you cannot hold on to it for too long, otherwise if markets are up small you end up in the loss area. So it’s best to sell this structure after one or two weeks at a small loss if markets don’t move much.

Also, this is a 4x structure so needless to say costs are high - usually at $0.65 per option.

In conclusion, there’s no free lunch in option space - so don’t forget the downside

Structures such as our skewed butterfly are meant to put the risk where you feel comfortable with it. So have fun creating option combos that fit your style and don’t forget the downside.

Option markets are efficient and there are no structural ‘free lunches’, no ways to combine options that always make money. Citadel Securities and the other market makers ensure this is the case, and arb away any micro-inefficiencies in the market in a matter of microseconds.