Thanks for the insightful post. I took off the trade this morning for 22.18 (don't kill me). You make a lot of sense here, I am looking for a candidate to buy a 1 month butterfly on, and will keep it delta neutral. Butterflies don't accumulate that much delta because the gamma is pretty low so I won't need to hedge as often as a short straddle. Once stock breaks strike take off the trade? From experience is this always the better trade? Do you ever think to just keep hedging your deltas? Thanks.
Actually have not traded butterflys in a while. What I used to do was enter at a premium of about 10% of maximum profit potential, during times of high implied probability, and "forget" about the trade until a couple of weeks before expiration. Because I tended to favor a direction on a 1-2-1, I paid a lot for my long out of the money option in premium as measured by the increased implied volatility compared to my short options. This reduced my profit expectation. For example, my long option would be slightly out of the money, my short options would be further out of the money, and my last leg would be very far out of the money. Although I nailed a 30 year t-bond expiration perfectly one time, overall, my results were middling and prefer more hands on type of trades.
On a month long butterfly, it is likely for one of the legs of the strike to be taken out at least briefly. My philosophy would be to size my investment such that the loss of the entire premium would not be too large of a percentage of my account. With two weeks or less to go, if the all the legs of the butterfly were significantly in or out of the money, I would close the position and take whatever net premium remained.
You can keep hedging your deltas or actively trade each part of the butterfly according to apparent high probability technicals. In addition, it's important to anticipate potential changes in volatility. For example, if you see a divergence between ATR and implied volatility, that would be worthy of further investigation. Where this divergence manifests itself into a trend change of volatility or the price of the underlying, you have increased potential of a nice trade, either outright or less hedged.
Take the time to deeply explore outright short options, short straddles, vertical spreads, ratio spreads, overwrites, 2-3-1's, 4-5-1's, and volatility ETFs. Back testing is truly your friend here.
The great thing about options is one's ability to closely match a trade with a specific scenario. The more exact your forecast of time and price, the greater your R/R can be. Today's narrower option spreads and commissions have created reasonable opportunities for knowledgeable retail traders.
