Topic: Pitchfork trading and discussion
I "invented" pitchforks a few years ago to take advantage of index skew. The idea was to define the skew algebraically and solve for a short volatility position which would survive an increase in strip-vol. A pitchfork is simply a same-strike ratio-straddle. The strike is chosen under spot to take advantage of the vol-smile.
A typical 3x1 pitchfork:
---1400--- Spot price 1398.00 --- 1400 straddle at 60, 120 (atm*2)
---1390---
---1380---
---1370---
---1360---
---1350--- Short 1 1350C // Short 3 1350P --- call 65, puts 17; 116 (3x1)
---1340---
---1330---
Vetting the position is very simple. You price the current atm straddle x 2 and solve for the furthest otm put strike which equals the credit received on the atm straddle (atm*2). The (atm*2) straddle is 4 atm options; it's no matter whether it's defined as two calls and two puts or four calls OR four puts, since they're ATM. I use the (atm*2) as an average premium as spot is typically not pinned to a strike.
The 1350 PF is trading at 116 in the above hypothetical example. The atm straddle parm is 120. A same-day trade to the 1350 PF strike will result in a 4 point loss at static vol. 120 - 116 = 4. Static vol is a HUGE qualifier, and the expectation would have to be that the math will not hold up in an immediate trade to your strike, regardless of gains from smile.
The trade can do well on strike touches due to sticky-delta/strike contamination. ATM vols tend to sta relatively stable within one sigma on price. IOW, your otm short strike vols will trend towards the reference atm vols as spot converges to strike. This occurs into the smile and against. Bull delta strikes will tend to increase while bear-deltas will tend to decrease -- INTO A STATIC STRIP VOL.
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