Broken wing butterfly

[Capt Hobbes]

Find a good position PnL simulator and play with it. Expiration PnL is pretty misleading for BWBs because unlike most other strategies, the curve doesn't just grow upwards into the expiration shape, it also moves horizontally, starting far to the left of the actual strikes. No voodoo here, it's simply because the verticals in BWB are asymmetric.

Here, take a look at the attached PnL for a SPY BWB (+184 -2x186 +190) open today in Feb 01'14 options. The white line is PnL halfway to the expiration on 1/17. See how at that time the maximum PnL is actually at about 183.3, below the nearest long strike. As time passes, that hump slowly grows and moves to the right. But even with a week to expiration it's still just past 184. You only start seeing something close the final expiration PnL in the last few days, both in terms of profit potential and the underlying price point.

 

[nixodian]

SIUYA, nice explanation for increasing cost of closing, as it approaches 185, l really thought profit would be increasing as it approaches 185, the expiration graph being part to blame. but opposite is true, loss increases; due to disparity in the two spreads as u explained and time value l guess. do you reckon a shorter time frame broken wing butterfly would be more beneficial? as would enter at a greater credit, > double, and price of underlying almost the same +/- few cents.

the real time profit and loss graph shows that it has really poor profit and loss returns, showing miniscule returns in comparison to losses all the way up to expiration. reason l thought it was an attractive strategy was Mark Sebastein of track the trade.com, comparing broken wing butterfly to buying a car and getting paid for it, drving it for a while , then selling it at a profit too.

sounds nice but it seems a bigger loss can occur, compared to profit received, confirmed by the real time PnL graph and this experience.

l have a stop placed, if SPY => 185.05, but by that time the spread will cost many times more to close, really poor PnL, where would you place the stop? and where would you place you target? l have a target set at 0.20. comments?

Quote from SIUYA:

As you have worked out - most of the graphs show what happens at expiration.....as to what happens in reality prior to this many strategies dont look as enticing.

The problem you have here is that of (for want of a better term )- relative decay , and try and think about this in conceptual terms rather than pure maths ....

You have 2 spreads - +183.5 to 185, and -185 to 188
These spreads react differently based on - time to expiry, skew, underlying etc.....they also react differently based on what they are worth now, and what they at best will be worth. (This is the conceptual part )
eg; the 150 spread can at max be worth 150. So if its currently at a price of .50, the most you can make is 3x your money. While at the same time the 300 spread might be worth .15 - at best you can make 20x your money. There are relative upsides downsides for each based on where you are now.
One might be increasing in price, the other decreasing in price over time ever so slightly - tending toward expiry day depending on where the price is however, until expiry day....these actually sometimes make the relative trading of the spreads have different skews. (as fair value is all a relative thing usually mainly relevant to market makers at any one particular point in time relative to other options.)

So - while this is a very crude way of thinking about it - for those not necessarily mathematically inclined it can help explain why options prior to expiry, dont necessarily correspond to those on expiry graphs, and you should not be fooled by them.

...........

think about it in terms of what happens on expiry day IN THE MORNING if the price is at 184.99
One spread has nothing but downside, the other has nothing but upside.....do you think you will be able to unwind at position at close to a maximum profit? Why would someone take the other side of that (assuming its a stand alone trade)? The time decay for these types of strategies often only occurs AT or effectively after expiry.
The joy of options!

 

[nixodian]

Capt Hobbes
totally agree expiration PnL very misleading esp for BWBs. so you have also entered a SPY BWB at almost same strikes, what was the price of SPY when you entered? enter at a credit? what are your stop and profit targets?
so are the PnL good for the BWB? looks reasonable in your chart, certainly doesnt feel like it for mine.

Quote from Capt Hobbes:

Find a good position PnL simulator and play with it. Expiration PnL is pretty misleading for BWBs because unlike most other strategies, the curve doesn't just grow upwards into the expiration shape, it also moves horizontally, starting far to the left of the actual strikes. No voodoo here, it's simply because the verticals in BWB are asymmetric.

Here, take a look at the attached PnL for a SPY BWB (+184 -2x186 +190) open today in Feb 01'14 options. The white line is PnL halfway to the expiration on 1/17. See how at that time the maximum PnL is actually at about 183.3, below the nearest long strike. As time passes, that hump slowly grows and moves to the right. But even with a week to expiration it's still just past 184. You only start seeing something close the final expiration PnL in the last few days, both in terms of profit potential and the underlying price point.

 

[nixodian]

Hooray, an ~ +0.07 will be achieved if closed with the close last Friday at 184.14. the delta of the spread is about -12, on December 31st SPY was at 184.5 closing at ~ -0.27.

according to a real time PnL chart, my losses should be increasing as the price increases from about 180. so why this unexpected credit of +0.07 as expiration approaches?

last Friday , when SPY was ~183.92 l could close at about +0.11 , at ~183.59 could close at ~ +0.14. Where would you place the stop now, credit of 0.12 received in the trade, so considering entering a stop order at around this figure, so profit doesnt get away. opinions?

 

[RichardRimes]

If it were me I would sit on it a bit longer. You have no risk to the downside....butterfly reaches max reward at 185 and you don't lose until 186.5 so I like it and if the market continues with this slow grind your fine. OTOH it's a very personal decision. What was your profit target when you did the trade? If you have reached it then close!

 

[nixodian]

Quote from RichardRimes:

If it were me I would sit on it a bit longer. You have no risk to the downside....butterfly reaches max reward at 185 and you don't lose until 186.5 so I like it and if the market continues with this slow grind your fine. OTOH it's a very personal decision. What was your profit target when you did the trade? If you have reached it then close!

Hi RichardRimes
figures you gave are right, right for expiration, but now its still a "long" way to expiration, and according to the "real" time graph, shows this "tiny" +0.07 profit will drop if SPY continues up, figures have also shown this, l only have a 0.12 cushion, gross, the credit l received. l did target 0.20, but last Friday, dropped it down to 0.13 for 1 of my 4 BWBs. according to candle price charts, it does look more likely to go up towards 185 before expiration 24th jan. what would you do?

 

[RichardRimes]

When you say "last" Friday, do you mean close this past Friday? .20 is very do-able so I'd definitely look for that price point. Set an "ask" price of .20 GTC to close the b-fly and see if it is hit in the next few trading days. Again what I would do is not relevent....its YOUR decision. Seldom do we make the perfect choice there is always a "what if" but if you plan a trade and it goes according to plan then its a great trade!

 

[nixodian]

yes it was very do able, when I looked the spread was at about (0.14 0.18) for about 20 mins when l was infront of my computer , a GTC close at 0.20 was already set up, it just decreased so l dropped the price to 0.13 and left it for last hours, that didnt get executed either.

the BWB really doesnt even closely match the BWB expiration graph that deceivingly makes it look profitable as it approaches 185, it doesnt, it losses increase significantly, so u reckon putting the stop at -0.12, the credit l received? for perhaps 3 of the 4 BWBs l have on?

 

[RichardRimes]

I don't like the idea of a stop on a defined risk trade. You already have a stop built into the trade. Focus on managing your winner. One option Im not wild about is close your imbedded short then you have no risk on the trade....however if I did that then I'd be looking for at least a .75 gain on the fly.