The Batman Options Spread is a sophisticated trading structure that is designed to capitalize on specific market conditions.
The payoff of this strategy resembles the silhouette of a bat and that’s why it is fondly called Batman Options Strategy!
It got its name in the Unofficed Forum Discussion long ago.
There are many different ways one can end up with this payoff graph.
Here we will discuss a spread that is a variation of the Double Long Butterfly Spread which is made of one is a Long Put Butterfly spread and another is a Long Call Butterfly spread.
Combining a Long Put Butterfly Spread with a Long Call Butterfly Spread creates a strategy that is essentially neutral to the direction of the market.
Here’s a detailed breakdown of the strategy:
Ideal IV Environment: High
Optimal Conditions After Entry:
Range-Bound with Expected Breakout: The market may have been range-bound but is showing signs of a potential breakout. In such scenarios, the Batman Options Strategy can capitalize on the breakout when it occurs.
Live Example of Batman Strategy:
To capitalize on the Batman Options Strategy, a trader should ideally:
In the above chart, You can see NIFTY had a gap down followed by sharp bearish days. It means –
It satisfies the best optimal condition!
So, Let’s execute the strategy as seen here –
Let’s calculate the premium collected and the maximum risk involved:
Premiums for the Straddle (Buy):
Premiums for the Near OTM Strangle (Sell):
Premiums for the OTM Strangle (Buy):
Net Premium Received:
Assuming that the net premium is negative, the trader will need the market to move enough to cover the cost of the premiums paid.
The maximum loss here is 370 INR only.
Profit and Loss Diagram
The payoff graph provided with the image indicates two profit peaks with a trough in between.
The ideal IV environment would have the following effects:
At the Peaks: High IV leads to greater premiums collected from the sold near OTM strangle. The strategy aims to maintain these peaks, where the profit potential is maximized.
At the Trough: If IV decreases after the strategy is in place, it reduces the value of the options sold, which is advantageous since the trader wants these options to expire worthless or be bought back at a lower price.
The ideal market conditions should enable the underlying asset’s price to finish near the peaks or within the trough at expiration for the strategy to be profitable.
In the context of the Batman Options Strategy, volatility skew is a critical element.
The volatility skew refers to the pattern where options with different strike prices but the same expiration date have different levels of implied volatility (IV).
Typically, out-of-the-money (OTM) options have higher IV than at-the-money (ATM) options due to the increased uncertainty and risk of ending up in-the-money as the option moves further from the current price of the underlying asset.
Here’s how the volatility skew plays a role in the Batman Options Strategy:
Selling Near OTM Options:
This part of the strategy aims to collect premiums while minimizing the risk associated with large swings in IV.
Buying Far OTM Options:
This aspect of the strategy is designed to protect against large, unexpected moves that could result in significant losses on the short near OTM options.
The strategy aims to balance the premiums received from selling the near OTM options against the cost of buying the far OTM options. In an ideal setup, the premiums from the sold options should be sufficient to cover the cost of the bought options, with excess premium representing potential profit.
The volatility skew is thus both a risk factor and an opportunity within the Batman Options Strategy. It necessitates careful consideration of the relative premiums and IV levels of the options at different strike prices.