Bearish Trading Strategy - with a twist

If you are bearish on an underlying, on low implied volatility names, you can:

-        Buy a naked put spread

-        Buy a put (hedged)

-        Buy an upside call (hedged)

Let's talk about the last trading strategy. It sounds counterintuitive, however, let's have a closer look. 

The interesting part is that, on a low implied volatility / high convexity underlying, the return is higher than on a hedged long put. See the detailed analysis below, for an instantaneous 5% down move.

Notes:

-         As the spot moves down by 5%, implied volatility follows the skew and is readjusted. Lets imagine (and this is purely fictive) that implied volatility moves up by 1% (fixed strike). Also, as we move away from our call, its implied volatility increases more (convexity). So we considered that for the call, the adjustment is 2 vols (This is an rough estimate - no science behind)

-        Being long the call, we end up with 9% delta, so we are still a bit short shares. Being long the put creates a larger delta position, so we are more and more long shares of a crashing underlying.

-        The highest performance is from the put spread strategy, we left it as a benchmark.