Butterfly Spread

The butterfly strategy is one of the most robust and versatile option selling techniques available.

In a lazy, quiet market condition there is very little - if anything - to do to manage these positions - other than watch your 0 day risk graph line rise up as your account grows - then close it out to collect your ‘trading paycheck’ at the end of the expiration cycle.

However, this is the case with basically all your standard theta positive monthly income type option strategies - like the iron condor, the calendar and double calendar - the double diagonal, etc.

What sets the butterfly strategy apart from the others is how this spread performs during extreme market conditions.

Ever since the crash in late 2008 delta neutral theta positive monthly income option trading has been a challenging endeavor. Yes, all the basic trades can and have worked - however during many of the months there is more work, adjustments, annoyance, and more stress involved then in past more peaceful times.

Out of all of the strategies - and I’ve traded them all through this period - the butterfly spread trade is the one that is the most robust - most consistent - most reliable - and the one that has given me the least amount of trouble and the most amount of profits.

And even though I do love condors - and I do love double calendars - and double diagonals… well - let’s talk about those later…

Anyway - if a low down dirty thug walked into my trading room one day and forced me at gunpoint to pick just ONE strategy I was allowed to trade for the rest of my life - it would have to be the butterfly spread.

I love you butterfly spread.

Where’s a tissue…

photo credit: mononukleoza

Technorati Tags: Butterfly Option, Butterfly Spread, butterfly strategy, Credit Spread, Iron Condor, Option Selling, Vertical Spread

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Non directional trading enthusiasts will many times use the butterfly option strategy as a way take advantage of a stock or index or ETF that is caught in a chart range - or an underlying whose options provide good premiums but doesn’t gyrate wildly around.

Because the short strikes of these butterfly spread positions are usually sold ATM (at the money - or at the position on the chart where the stock or underlying asset is currently trading at) a large amount of premium - in fact largest amount that is possible - is collected at the start of the trade.

Again, option spread traders who use this option trading strategy will want to choose the underlying asset wisely - one which is either stuck in a price range or an underlying that doesn’t normally surprise, gap, or fly around on the chart. Many butterfly option traders prefer indexes or ETFs for these types of trade for this very reason.

As long as the the correct stock or index is chosen and the butterfly trade is placed, managed, and removed correctly - an individual can extract great monthly returns over time using this spread trading strategy.

photo credit: SearchNetMedia

Technorati Tags: Butterfly Option, Butterfly Spread, Credit Spread, Iron Condor, iron condors, Vertical Spread

Butterfly Spread Trades can be composed of all call options, all put options, or both call and put options.

Regardless of how they are constructed - for the most part they appear the same in a trading platform risk graph pay off diagram window - and also for the most part they perform the same while the trade is on.

There are instances where exiting the butterfly spread trade can become somewhat of an issue when using an ‘all call option’ butterfly - or an ‘all put option’ butterfly.

This usually has to do with situations where the debit spread side of the trade becomes so far ‘in the money’ that it can be difficult to get a nice fill on those in the money option / spread when trying to exit the trade.

One way that this situation can be dealt with is to create a ‘box’ on the trade - which is buying and selling the exact opposite options that are so deep in the money. The exact opposite side of the trade will be out of the money and should be much easier to fill - and when done can ‘lock in’ the profit on that part of the trade.

photo credit: jontintinjordan

Technorati Tags: butterfly call spread, Butterfly Option, Butterfly Spread, Credit Spread, Iron Condor, iron condor spread, iron condors, Option Selling, option spread trading, Vertical Spread

Someone forwarded these trading quotes to me this morning and I thought I’d pass them on…

“Just when you think you are smart, the market will show you just how really dumb you are.”  - Louis Navellier

“There are two kinds of investors, be they large or small: those who don’t know where the market is headed, and those who don’t know that they don’t know. Then again, there is a third type of investor – the investment professional, who indeed knows that he or she doesn’t know, but whose livelihood depends upon appearing to know.” - William Bernstein

Credit Spread

Technorati Tags: Butterfly Spread, Credit Spread, Iron Condor

March 2010 Expiration

Our Butterfly Spread Trade this month did beautifully. Opened this trade on 2-17-10. Closed it on 2-25-10 for a profit of just over 10% in 8 days.

Technorati Tags: Butterfly Option, Butterfly Spread, Credit Spread, Iron Condor

photo credit: dno1967

A butterfly spread is an options spread trade that takes advantage of the fact that options are decaying assets.

Butterfly spread traders SELL the options that have the MOST time premium - or the options that the MOST ‘fake’ or ‘unreal’ value.

As long as the underlying they are trading stays within a range - which the probabilities say they should - the trader should be able to ‘capture’ a large percentage of the TIME value as it disappears into ‘thin air’ - as time goes by.

The closer the trade gets to expiration day - the options will decay at a faster and faster rate.

And the butterfly trader only needs a small fraction of the premium he or she originally brought in by selling the at the money options to realize a very good return on investment.

And what happens if things don’t go so well - and the underlying doesn’t stay within the ideal range?

The trader is then able to utilize the huge amount of premium he or she brought into the trade by selling the At The Money options to ‘fund’ a number of different available adjustment techniques to keep the trade profitable.

Technorati Tags: Butterfly Option, butterfly options, Butterfly Spread, Credit Spread, Iron Condor, what is a butterfly spread

photo credit: dno1967

Traditionally traders might consider the Butterfly Spread to be a ‘neutral’ strategy - one that is used when the trader believes that the underlying being used will not move much and will remain in a relatively narrow range.

And while of course butterfly spreads do work - and work wonderfully - in such situations, butterflies can also be used if the trader believes the underlying will be making a directional move.

The thing with butterfly spreads is that you want to place the short strikes of the trade either at or as near as possible to where the underlying will be trading at expiration day. That is how and where the money is made in these trades.

So, if a trader had a directional bias on a particular underlying - and thought that it would rise up to a certain price within the time period to expiration - that trader could place a butterfly as a bullish spread.

To do so the trader would place an OTM (out of the money) butterfly trade with the short strikes sold at or near the strike price where the trader believed the underlying would be at expiration.

If the trader wanted to give himself more ‘room to be wrong’ he could place a wider butterfly - with the wings being further away from the sold short strikes - allowing his ‘profit tent’ to encompass a wider area of profitability around the sold short strikes.

If the trader had a crystal ball and was certain the underlying would wind up at a specific strike price at expiration day - he would want to sell a narrow butterfly trade - with the wings being as close to the sold strikes as possible - which would give him an enormous profit with very little risk in the trade - as long as of course, his crystal ball was right.

Technorati Tags: bullish spread, Butterfly Option, Butterfly Spread, Credit Spread, Iron Condor

photo credit: timlewisnm

When trying to understand a more complex options strategy, many times I find it easier to ‘reverse engineer’ the position, break it apart into pieces -understand what exactly those pieces are that make up the trade, then put them all back together again.

For example, an alternate way to look at the Iron Butterfly Spread is break the position apart and realize that this trade is actually just the Sale of a Straddle.

For example, the original iron butterfly position might look something like this:

Buy 1 35 Put
Sell 1 40 Put
Sell 1 40 Call
Buy 1 45 Call

However, when we break it apart, we could say that this trade is simply a sale of a straddle…

Sell 1 40 Straddle

and the purchase of a strangle…

Buy 1 35/45 strangle.

The sale of the 40 straddle is what the trader is utilizing to bring in the income.

The purchase of the 35/45 strangle is used as protective wings.

Technorati Tags: Butterfly Option, Butterfly Spread, butterfly straddle, Credit Spread, Iron Condor

photo credit: dev null

There a several different types of butterfly spreads traders can put on.

Traditionally there is the call butterfly and the put butterfly. The call butterfly is constructed from ONLY call options - while the put butterfly is constructed from ONLY put options.

An example of a call butterfly would be:

Buy 1 25 Call
Sell 2 30 Calls
Buy 1 35 Call

And an example of a put butterfly might be:

Buy 1 60 Put
Sell 2 65 Puts
Buy 1 70 Put

Then there is the Iron Butterfly, with is made up from both calls and puts. One way to think of this butterfly spread is as an Iron Condor with the short strikes of either side being sold at the same strike price - or ‘glued’ together.

An example of an Iron Butterfly could look as follows:

Buy 1 45 Put
Sell 1 50 Put
Sell 1 50 Call
Buy 1 55 Call

Then there is the ‘Skewed Butterfly’ or the Broken Wing Butterfly.  In the above examples, the butterfly spreads shown had wings that were bought an equal distance away from the short strikes on either side. In the case of the Skewed or Broken Wing Butterfly this distance is not equal.

An example of a Skewed or Broken Wing Butterfly could looks as follows:

Buy 1 50 Call
Sell 3 55 Calls
Buy 1 65 Call

Technorati Tags: Butterfly Option, Butterfly Spread, butterfly spread example, Credit Spread, Iron Condor