Net Credit Butterflys...

[jones247]

Butterflys are typically a low risk/low probability trade, having a small debit when established. However, why not create a more worthwhile tradeoff? If one were to implement a mixture other than 1-2-1, such as 1-3-2, then you can create a net credit fly... Some may consder this to be a fly combined with a credit spread. In any event, a net credit position is created with a higher probability of success (profit). However, the tradeoff is a 1:1 risk:reward ratio.

Sometimes it's better to give up r:r for a higher probability of success. A trade such as this will be profitable as long as the market price does not go beyond the "body" strike price. If necessary, just liquidate the position early, instead of waiting until expiration.

Walt

 

[dagnyt]

Quote from jones247:

Butterflys are typically a low risk/low probability trade, having a small debit when established. However, why not create a more worthwhile tradeoff? If one were to implement a mixture other than 1-2-1, such as 1-3-2, then you can create a net credit fly... Some may consder this to be a fly combined with a credit spread. In any event, a net credit position is created with a higher probability of success (profit). However, the tradeoff is a 1:1 risk:reward ratio.

Sometimes it's better to give up r:r for a higher probability of success. A trade such as this will be profitable as long as the market price does not go beyond the "body" strike price. If necessary, just liquidate the position early, instead of waiting until expiration.

Walt

Walt,

Certainly viable, but this is still essentially the credit spread as a standalone - because that's where the risk lies.

The butterfly sort of disguises that fact and adds extra profits in one half of the butterfly's profit zone and reduces them in the other half.

Mark

 

[spindr0]

Quote from jones247:

In any event, a net credit position is created with a higher probability of success (profit). However, the tradeoff is a 1:1 risk:reward ratio. Sometimes it's better to give up r:r for a higher probability of success. A trade such as this will be profitable as long as the market price does not go beyond the "body" strike price. If necessary, just liquidate the position early, instead of waiting until expiration.

I don't see that you've achieved a higher probability of success. To extend what Mark said, all you've done is shift the bias of the butterfly to less risk to the downside, more gain if unchanged and more risk to the upside. IOW, the credit from the vertical raises the left side of the butterfly and the potential debit loss increases the risk on the right side. Expected profit won't be very different b/t the two positions.

 

[jones247]

Here's the rub, the real beauty of such a strategy... initiate a call combo and a put combo... if the stock at expiry fall anywhere between the breakeven point for the put and call combos, you're o.k. You still have the potential of a major win if the price of the stock is at the short stike when expired. Moreover, if it remains or moves up or down between the two short strikes, then at a minimum you'll keep the net credit received.

I believe this is awesome... I'm willing to share it as a way of giving it a "stress test"... If I have neglected a potential "weak link", please let me know... Nonetheless, my biggest worry is a rise in IV...

Walt

 

[spindr0]

>> Here's the rub, the real beauty of such a strategy... initiate a call combo and a put combo... if the stock at expiry fall anywhere between the breakeven point for the put and call combos, you're o.k. You still have the potential of a major win if the price of the stock is at the short stike when expired. I believe this is awesome. <<

1) Awesome? The real beauty of every strategy is if the underlying stays in the sweet spot of the risk graph. Everyone gets that win if their stock behaves perfectly.


>> I'm willing to share it as a way of giving it a "stress test"... If I have neglected a potential "weak link", please let me know... Nonetheless, my biggest worry is a rise in IV. <<

2) No, your biggest fear should be big movement toward the side with the added vertical. With an equal number of long and short legs, IV changes won't be dramatic. In the sweet spot in the body, profit will be reduced but IV increase will actually be helpful with a significant price increase.

 

[JohnGreen]

Walt, you and I had previous discussions about a double broken wing butterfly which relates to this discussion as there are essentially three kinds of unbalanced flies--
(Style A) which operates with the usual 1-2-1 ratios combined with uneven strikes like 550/560/580-- (Style B) which uses unbalanced ratios like 1-3-2 and even strike spacings
and (style C) which uses a combination of unbalanced ratios and spacing, and which may require margin depending on the ratio and the spacing. A typical version of type C is called a split strike fly and it may look like this 1-550 strike call, (-6)-600 calls and (5)-610 calls. This version requires a net debit, but no margin because it cannot lose more than the initial debit. BOTH style A and B butterflies usually are set up to create a net credit to start with which means that the downside territory (I'm assuming you are using calls, but puts can also be used, as well) is profitable in a limited way. BOTH of these butterflies require margin because there is an upside risk zone which begins to cut into profits and finally create substantial losses above the middle strike as you approach the upper strike (using calls, of course).

Both Spin and Mark are absolutely correct when they imply that there is one (or in some cases more than one) vertical spread embedded in the position that creates the credit as well as the upside risk.

These fly styles are not inherently better than regular butterflies. Although the profitable zone is much larger than regular flies, the possible magnitude of loss is also much larger.
These types of butterflies require more careful watching than regular flies because there is that small chance of a bigger loss.

By the way, did you create the RUT double butterfly? I did, and it is currently profitable, although not in a spectacular fashion. Unfortunately, I was ultimately unable to receive the 80 cent midpoint, which will limit the overall profitability of this position. However, since the market has remained range bound for the last few days, the probability of success has risen noticeably.

 

[jones247]

Hi John,

Thanks for the thought provoking comments. Indeed, I did execute a Broken Wing Butterfly, call & put, on RUT... The more I test variations on the butterfly strategy, the more intrigued I become. I like the notion of a credit position in the event that the price Does Not go to the "sweet spot", yet it'll still be profitable.

Walt