In the last post, we learned about Pascal’s triangle.

Here is the first red (H1) outright:

Notice the range and stability. Focus on these as we proceed.

Next we will do a simple H1M1 spread (Long H1, Short M1):

Moving forward to the H1-M1-U1 butterfly (Long, Short 2x, Long):

Next, we try out the double butterfly (long, short 3, long 3, short 1):

And now on to the more exotic structures (Long 1, Short 4, Long 6, Short 4, Long 1):

And slightly more exotic (Long 1, Short 5, Long 10, Short 10, Long 5, Short 1)….you starting to get the point here?

Again notice the reduction in overall portfolio variance as you add more components. Think about the correlation and volatility curves that we showed you previously. How are you capitalizing on that? What are the risks with these strategies in the front of the curve (H0,M0,U0,Z0)? Consider holding time as you start to build these larger exotic positions as they tend not to move that much.

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