help with my butterfly

J

jonbig04

I'm not yet familiar with all the terminology, sorry if i name anything incorrectly.

I'm considering doing a butterfly call spread on a certain stock.

I want to buy 1 contract (yes im only playing with around $1,500) of October calls at a certain strike and simultaneously sell 1 July call at the same strike.

The premium I collect is about 24%. I realize of course if the stock tanks I could be out as much as 76% of my investment, but thats a risk I'm willing to take. However I am confused on one part, and honestly I may just be doing my math wrong.

I'm trying to simulate a price jump of $30 of the underlying on July 15th and I'm assuming the stock stays there until expy. I multiplied the theta by how many days that is from now for both options, subtracted that from the option's current price and then multiplied the deltas respectively for a $30 price jump and added them together to simulate how much each option would be worth. The theta on the option i bought for myself is 0.078 while the theta on the option i sold is 0.115. Also my delta is 40% higher than his. When I do the calculations and assuming he exercises and I have to pay the difference between the strike and the stock price, I end up losing money. Not very much, about 5%-10%. My question is how can this be? With the deltas and thetas being what they are how does the person I sold the option to get "ahead" of me?

Also I with there was some kind of simulator thing, bc all these greeks become a pain to deal with.

Any advice is appreciated.
 
Hard to make a comment without more information (like, the strikes you ae looking at, and whether they are ATM or not) but I think I get the nugget of your question...

The simple answer is probably gamma - it is higher for the near term short ("his") option. That means delta will change faster, and the difference in deltas between the two months will narrow as the stock moves away from their strikes. Lots of other intracacies affecting this sort of trade though - not the least of which, theta does not stay constant, but will accelerate.

Most important of all, vega will make all those numbers change every day, even with a slight change, as the vega of the far off option is quite a bit higher. As a matter of fact, that is what this trade (a time spread, not a butterfly btw) is designed for - to profit from an increase in IV on the underlying. If you try one of these with a very high IV, and it drops during the trade, you could lose no matter what it looked like when you you opened it. Think about that...

I'd do some googling for calendars or time spread rules, and watch a webcast at the CBOE site (Dan Sheridan has some great rules for them) before trying these for real. More often than not, these usually have to managed and adjusted (usually by openeing up another one at another strike) to show have better than a 50/50 chance of a profit.
 
Quote from dethkultur:

Hard to make a comment without more information (like, the strikes you ae looking at, and whether they are ATM or not) but I think I get the nugget of your question...

The simple answer is probably gamma - it is higher for the near term short ("his") option. That means delta will change faster, and the difference in deltas between the two months will narrow as the stock moves away from their strikes. Lots of other intracacies affecting this sort of trade though - not the least of which, theta does not stay constant, but will accelerate.

Most important of all, vega will make all those numbers change every day, even with a slight change, as the vega of the far off option is quite a bit higher. As a matter of fact, that is what this trade (a time spread, not a butterfly btw) is designed for - to profit from an increase in IV on the underlying. If you try one of these with a very high IV, and it drops during the trade, you could lose no matter what it looked like when you you opened it. Think about that...

I'd do some googling for calendars or time spread rules, and watch a webcast at the CBOE site (Dan Sheridan has some great rules for them) before trying these for real. More often than not, these usually have to managed and adjusted (usually by openeing up another one at another strike) to show have better than a 50/50 chance of a profit.
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I guess its not a big deal to say it, they are OTM and the strike is $195 or $15 from today's close. So this is called a time spread? I will definitely take your advice and google it and that video. It makes sense what you said about vega and gamma, I didnt even think about those. Thanks for your reply.
 
Quote from jonbig04:

I'm not yet familiar with all the terminology, sorry if i name anything incorrectly.

I'm considering doing a butterfly call spread on a certain stock.

I want to buy 1 contract (yes im only playing with around $1,500) of October calls at a certain strike and simultaneously sell 1 July call at the same strike.

The premium I collect is about 24%.Any advice is appreciated.
More...
You are selling the front month and buying the back month, same strikes. That's called a calendar or time spread. It is done for a debit, NOT a credit, i.e. you DON"T collect a premium, you pay it.
Your max risk is not 75% of your trade capital. Your max risk is the debit you pay to open the position, iow you risk 100% of your trade capital should the position go against you and you do nothing.
As for the rest of your question, just open a trading account and use their modelling software (e.g TOS) to do your simulations - it's a lot quicker.
Good advice from dethkultur (Sheridan/CBOE free webinars, other materials).
db
 
Quote from daddy'sboy:

You are selling the front month and buying the back month, same strikes. That's called a calendar or time spread. It is done for a debit, NOT a credit, i.e. you DON"T collect a premium, you pay it.
Your max risk is not 75% of your trade capital. Your max risk is the debit you pay to open the position, iow you risk 100% of your trade capital should the position go against you and you do nothing.
As for the rest of your question, just open a trading account and use their modelling software (e.g TOS) to do your simulations - it's a lot quicker.
Good advice from dethkultur (Sheridan/CBOE free webinars, other materials).
db
More...


I think i understand what you're saying, I didnt at first. My main confusion was to do with...procedure i guess. I assumed that the premium you got when you soold your short went into you account, and the long you bought was seperate, but im pretty sure the broker just applies your premium to the price of your long...in which case you could lose everything you put in..right :confused:

I've dont quite a few simulations...I wish I could backtest them somehow, it sucks waiting a whole month to see what would have happened.
 
You should check out a couple of demos and see which ones you like. (IB, Tradesstation, Think or Swim, Options express, etc)
if you don't have a strong understanding of these somewhat complicated formulas; losing money is easy enough with vanilla strategies. Watch out for the holy grail. Read "trading options for a living" and understand the expectancy of each trade.
 
Quote from jonbig04:

I think i understand what you're saying, I didnt at first. My main confusion was to do with...procedure i guess. I assumed that the premium you got when you soold your short went into you account, and the long you bought was seperate, but im pretty sure the broker just applies your premium to the price of your long...in which case you could lose everything you put in..right :confused:

I've dont quite a few simulations...I wish I could backtest them somehow, it sucks waiting a whole month to see what would have happened.
More...

You really should sign up for a brokerage account with thinkorswim. You can papertrade, live trade, and analyze anything you could possibly think of regarding options.

On a calendar or time spread, the sold front month option is sold by you at less than the value of the back month option you purchase.

This means you pay for the calendar to open it because the premium received for selling the front month option is lower than the amount you had to pay to buy the back month as a hedge, but you don't "lose" that money spent.

Your profit/loss is essentially zero at that moment. Without taking commissions into account, if the prices didn't change in the next minute and you re-sold/re-bought the options to clear out your position you would re-receive the same amount of $ you originally spent or something very close to it (due to bid/ask differences).

Your profit is derived from the value of the front month option declining faster than the back month.

Example of one of my recent calendar positions (commissions are not included):

On 4/23, I opened a calendar position on LMT:

I sold a 105 May call for $3.10.
I bought a 105 June call for $4.30.

I had to pay $1.20 difference to open the position.

On 5/8 to close the position:

Sold the June 105 call for $3.30
Bought the May 105 call for $1.68.

The math:

May sold @$3.10, bought at $1.68 = +$1.42
June bought at $4.30, sold at $3.30 = -$1.00

Profit = $0.42.
 
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