This post is another in a series that we will be publishing which track the hypothetical performance of broken wing butterfly trades selected by Greg Loehr of Optionsbuzz.com.
I promised to follow up to my earlier post tracking a hypothetical SPX weekly broken wing butterfly, so here it goes.
Using the options that expire tomorrow the butterfly is long the 1380 puts, short twice as many of the 1375, and long the 1365 put as protection. This trade is being tracked with an entry price of a 35-cent credit. That creates a theoretical maximum risk of $4.65; and maximum profit of $5.35. Both the max loss and max profit are unlikely to be hit.
The maximum loss would require about a 51 point loss between now and tomorrow. Based on the current implied volatility there’s approximately less than 1% chance of that occurring. The max profit would require the index to pin at 1375. There’s probably a better chance for the Chicago Cubs to win the World Series next year than having this trade getting to the max profit of $5.35.
But understanding that the trade can have a profit that’s greater than the 35-cent is another nice attribute of this kind of trade. Here’s why.
If we take the max risk (and it’s accompanying margin requirement) out of consideration just for this example, then we take in the 35-cent credit from buying the butterfly to open this trade. When you go to sell the butterfly, prior to expiration, it’s possible that you can receive another credit. Credit to open the trade; credit to close.
Or, it’s possible that you could close the trade by selling the butterfly for “even money”. The ability to do this, market conditions warranting of course, means two major things to a trader:
1. You take your profit prior to expiration and close the risk. This is different from your typical credit spread in which case you can only keep the opening credit by taking the trade all the way through expiration.
2. Closing the trade and removing the risk means that you can put on another position with the margin that was locked up by your broker. That’s really nice since the weekly options get listed on Thursday.
If this trade can be closed for “even money” or better, I’ll let you know. Otherwise we can safely assume that the butterfly will go out worthless tomorrow barring any fireworks in the market. In my next post I’m going to take a look at maximizing a butterfly based on the myriad of strikes and expirations.
Trade safe!
Greg Loehr
Please note: Hypothetical computer simulated performance results are believed to be accurately presented. However, they are not guaranteed as to accuracy or completeness and are subject to change without any notice. Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Since, also, the trades have not actually been executed; the results may have been under or over compensated for the impact, if any, of certain market factors such as liquidity, slippage and commisions. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any portfolio will, or is likely to achieve profits or losses similar to those shown. All investments and trades carry risks.
No relevant positions.