Hello everybody. This is my first post on this forum. I've recently started options trading (paper acc) and have some questions regarding butterfly strategies. I mean classic butterfly: +1 call -2 calls +1call As i understand butterfly is a delta neutral strategy which depends only on IV and market moves. Delta, Gamma and etc work only inside the wings. All my p&l depends on expiration price of unrelying. Is that all or something else exists which i don't know? Is it possible to open credit butterfly(-1 +2 -1)? TOS shows that it's possible and even profitable. The only risk here if it expires inside the wings and this risk is 4-10 times greater than profit - it's scaring. So how may i hedge this risk if i succesfully open credit butterfly? And why everybody do not trade these butterflys and developing more complicated strategies? Thanks a lot)
A butterfly is about delta neutral ATM, but it can be used as a directional strategy as well, if you set it up OTM. You don't need to hold a butterfly to expiration to make a profit. Time decay is also an important component of a butterfly. Yes, you can trade a butterfly where you are short the wings and long the body, in which case you would open it for a credit. The strategy is profitable if the underlying moves outside the wings. You can think of it as a long straddle that has capped profit potential. There is always a trade off between risk and profit, if you fully hedge the risk you automatically reduce your profit potential to the risk free rate, which is currently nothing. On the other hand, opening a butterfly where you are short the body and long the wings for a credit is a whole different animal. This can only be done if you leg in to the spread and once you have it, it is a risk free position with a very nice potential profit. And what makes you think that nobody trades these and other multi-leg spreads? A lot of people and institutions trade these.
You've mentioned that i don't need to wait till expiry. Does it mean that as soon as the price of underlying breaks through the wings or IV rises/falls the way I may close my position for profit I should immediately close the position and donât wait, right? And btw I still do not understand the one thing â if I have the open profitable position in any option (excluding naked shorts) and immediately want to close it, what I lose? Only commissions and unrealized profit? The last question â what are the main disadvantages of selling wings and buying body? I have the following ideas â 1) It works only when market moves in any direction; 2) Profitability and risk are limited but risk is 3-10 times greater than profit; 3) Chances of expiration inside the wings exist and real so we need to receive profit for about half a year to reach break-even point for one loss. Itâs all. Any additional ideas? Thanks
You've mentioned that i don't need to wait till expiry. Does it mean that as soon as the price of underlying breaks through the wings or IV rises/falls the way I may close my position for profit I should immediately close the position and donât wait, right? And btw I still do not understand the one thing â if I have the open profitable position in any option (excluding naked shorts) and immediately want to close it, what I lose? Only commissions and unrealized profit? The last question â what are the main disadvantages of selling wings and buying body? I have the following ideas â 1) It works only when market moves in any direction; 2) Profitability and risk are limited but risk is 3-10 times greater than profit; 3) Chances of expiration inside the wings exist and real so we need to receive profit for about half a year to reach break-even point for one loss. Itâs all. Any additional ideas? Thanks
your short term paper profit will be based on the net delta of the butterfly. over medium term theta decay plays more of a part as well. you can close it at any time close to value which will be determined by the delta movement and the time decay. usually commissions (4 options) will make a butterfly not worth the trouble.
In my experience, if you buy a cheap fly in an attempt to pin the strike, the mkt won't give you your money almost until expiry, even if you're right in the sweet spot. I like to buy cheap flies like lottery tix sometimes.
Options as a percentage are a small part of my portfolio. When it comes to option spreads, butterflies is pretty much all I do. As a standalone I agree they are a lottery ticket. If you do a round trip buying and closing out you have commissions for 8 contracts â so they are expensive. When I buy them, I consider the debit paid, to be my maximum stop loss â meaning I donât try to repair them with other options or options spreads; if they are a loser I close them out or if they are out of the money I may just let them expire worthless. However if I have a butterfly with the market price close to one of the long strikes (the breakeven price on the expiration graph), depending on whether I am looking at positive or negative deltas (expiration graph), I sometimes short the underlying when looking at long deltas on the butterfly spread or go long the underlying when looking at negative deltas on the butterfly spread. When I do this, the underlying deltas are either less negative or less positive than spread deltas (expiration graph) depending on what long strike I am at. Usually, I only do this close to expiration and âclose to expirationâ is discretionary based on a few different factors. I never sell butterflies, except to close them out. I used to do unbalanced butterflies 1 -2 1 ratio with the strikes not equidistant. These were like quasi ratio writes except they had a defined risk. But, even though they were a defined risk, I still had to watch them and be prepared to close them out when they hit different prices at certain times before expiration. Too much work in terms of monitoring.
If I buy call butterfly and I am wrong with market direction. How can I hedge the position, e.g. buy put debit spread? Or is it better to buy put butterfly too? I mean both OTM butterflies. I do not like so many legs used though. Is it better to use OTM butterfly on 1 - 2 week time frame or longer time frame (month+)? What is the optimal range between strikes for AAPL for example. The wider the better but wide butterflies are expensive. If to open a $5 wide (300-305-310) OTM butterfly will it gain any good profit before expiration if market moves in correct direction?
Atticus has posted two very educational journals where he trades butterflies: "atticus' single-name delta book" http://www.elitetrader.com/vb/showthread.php?s=&threadid=253092&perpage=6&pagenumber=1 "atticus' 'ship it' vol trading journal" http://www.elitetrader.com/vb/showt...=248751&highlight=ship+it+vol+trading+journal I learned more from these than anything else on ET to date.