Walt Disney Company (DIS) Iron Butterfly Trade has an expected value ROI of 58.75% for Option Seller

[Raltin]

Why Sell Iron Butterfly trades?

• Iron butterflies are direction neutral and primarily a bet on the spread between the implied volatility versus the underlying stock volatility.
  
  
• Iron Butterfly trade ideas are based on selling straddles and buying strangles because historical probability distributions are easier to model (given enough analytical / computing horsepower) with a closer expiry date. Selling very far OTM Puts and calls are harder to model because of fat tail distributions (See Taleb commentary on selling tail options vs volatility in the body)
  
  
• For Iron Butterfly sellers, even if the underlying asset moves against you, the losses are limited and the premium collected could be justifiable from an expected value perspective.
  
  
• Expected values are generated using past historical stock volatility tables and computed using a cumulative probability density function at various potential stock changes.
  
  
• Executing an entire basket of Iron Butterfly trades may have a higher chance of success than executing any one single trade

Raltin Methodology for Identifying Iron Butterfly Trade Ideas:

• We calculate probabilities for all combinations of stock moves and time periods for every stock. For e.g. What is the probability of The Walt Disney Company (DIS) moving 10%/9%/8% etc for every period 7/8/15/30/31/32 day etc. This is a very computationally intensive process but far superior to an assumption of the curve of the stock patterns and then approximating that through standard deviation. Here is some background from Taleb on the challenges of using Standard Deviation for modeling.
  
  
• Based on the probability tables for every single combination of stock move and period- we compute a cumulative probability density function for the various stock changes. That is in the 2nd chart you see below. For e.g. what is the probability of DIS closing above 6/7/8/8/10% etc in X days?
  
  
• Once we compute the density function- we then run the expected value for each point in the stock price and then sum up the expected value for the option seller

Company Background and Key Events:

• Company Background: The Walt Disney Company is an American diversified multinational mass media and entertainment conglomerate headquartered in Burbank, California, at the Walt Disney Studios. The company’s market cap is USD 254.93 Billion and has an annual revenue for the year 2019 being USD 59.76 Billion.
• Key Events: Earnings and other information: The Company’s Ex-Dividend date is 5 July 2019, and the estimated interim results of the company is expected on 5 August 2019.

TRADE DETAILS OF THE WALT DISNEY COMPANY - DIS - IRON BUTTERFLY - JUNE 28 2019

• Expiry Date of Options: Aug 9th 2019 (30 Trading Days)
  
  
• What is the trade?: Sell 140 Calls ($4.6) & Puts ($5.15) and Buy 125 Put ($0) and 155 Call ($0). (Note: The OTM Put & Call Price was zero on June 28th because those options were not traded and even offering a marginally higher price for those OTM strikes should not impact the expected value and ROI calculations by a substantial amount)
  
  
• Stock Price as of June 28 2019: 139.64
  
  
• What is the Net Option Premium / Max Profit to the Option Seller: $9.75
  
  
• What is the Maximum Loss to the Option Seller?: $5.25
  
  
• What is the expected value of the trade to the option seller based on probability calculations of past historical stock movements of the stock?: $3.08
  
  
• What is the ROI (Expected Value / Max Loss) to the Seller?: 58.75% ($3.08 / $5.25)
  
  
• How much should the Stock Move for the Option Seller to Start Losing Money? 7.2% (For Calls) and -6.7% (For Puts)
  
  
• How much should the Stock Move for Option Seller for the Max Loss ? 11% (For Calls) and -10.48% (For Puts)
  
  
• What is the Probability of the Trade Being Profitable for the Option Seller (Green Zone in Chart)?: 75.69%
  
  
• What is the Probability of the Trade Being Unprofitable for the Option Seller (Yellow + Pink Zone in Chart): 24.31%
  
  
• What is the Probability of a Maximum Max Loss for the Option Seller (Pink Zone in Chart): 11.75%
  
  
• What is the current (52 Week - High / Low) Implied Volatility for at the Money (ATM) Options? - 21% Current (14%- 52 Week Low & 37% - 52 Week High)

 

[minmike]

Calls are .60 and puts are .40. Why do you think you are getting them for free?

 

[Raltin]

Yes. We added a note in the original post commenting on the issue.

We are re-posting the edited comment here:

(Note: The OTM Put & Call Price was zero on June 28th because those options were not traded and even offering a marginally higher price for those OTM strikes should not impact the expected value and ROI calculations by a substantial amount)

 

[minmike]

How can reducing your potential profitby 10% and increasing your potential loss by 20% not substantially change your ROI or expexted value?

Yes. We added a note in the original post commenting on the issue.

We are re-posting the edited comment here:

(Note: The OTM Put & Call Price was zero on June 28th because those options were not traded and even offering a marginally higher price for those OTM strikes should not impact the expected value and ROI calculations by a substantial amount)

 

[Option_Attack]

Just for fun here are 10 years of 3rd Friday to 3rd Friday changes:
Changes over +-5% are highlighted.

Third Friday to third Friday changes (at Close) for DIS

Start 20090821 Price: 26.79

20090918, 28.44, %Chg: 9.17
20091016, 29.40, %Chg: 3.38
20091120, 30.01, %Chg: 2.07
20091218, 31.95, %Chg: 6.46
20100115, 30.60, %Chg: -4.23
20100219, 31.23, %Chg: 2.06
20100319, 33.64, %Chg: 7.72
20100416, 35.83, %Chg: 6.51
20100521, 32.87, %Chg: -8.26
20100618, 35.15, %Chg: 6.94
20100716, 33.03, %Chg: -6.03
20100820, 33.05, %Chg: 0.06
20100917, 34.56, %Chg: 4.57
20101015, 34.88, %Chg: 0.93
20101119, 37.01, %Chg: 6.11
20101217, 37.05, %Chg: 0.11
20110121, 39.74, %Chg: 7.26
20110218, 43.56, %Chg: 9.61
20110318, 41.23, %Chg: -5.35
20110415, 41.52, %Chg: 0.70
20110520, 41.50, %Chg: -0.05
20110617, 38.04, %Chg: -8.34
20110715, 39.27, %Chg: 3.23
20110819, 31.85, %Chg: -18.89
20110916, 32.91, %Chg: 3.33
20111021, 35.16, %Chg: 6.84
20111118, 35.63, %Chg: 1.34
20111216, 35.32, %Chg: -0.87
20120120, 39.31, %Chg: 11.30
20120217, 41.75, %Chg: 6.21
20120316, 43.19, %Chg: 3.45
20120420, 42.35, %Chg: -1.94
20120518, 43.81, %Chg: 3.45
20120615, 47.05, %Chg: 7.40
20120720, 48.59, %Chg: 3.27
20120817, 50.46, %Chg: 3.85
20120921, 52.74, %Chg: 4.52
20121019, 51.90, %Chg: -1.59
20121116, 47.42, %Chg: -8.63
20121221, 50.00, %Chg: 5.44
20130118, 52.34, %Chg: 4.68
20130215, 55.61, %Chg: 6.25
20130315, 57.58, %Chg: 3.54
20130419, 61.56, %Chg: 6.91
20130517, 66.58, %Chg: 8.15
20130621, 62.73, %Chg: -5.78
20130719, 65.16, %Chg: 3.87
20130816, 62.17, %Chg: -4.59
20130920, 65.01, %Chg: 4.57
20131018, 67.15, %Chg: 3.29
20131115, 70.00, %Chg: 4.24
20131220, 72.40, %Chg: 3.43
20140117, 73.98, %Chg: 2.18
20140221, 80.13, %Chg: 8.31
20140321, 80.35, %Chg: 0.27
20140417, 79.99, %Chg: -0.45
20140516, 80.39, %Chg: 0.50
20140620, 82.82, %Chg: 3.02
20140718, 85.81, %Chg: 3.61
20140815, 89.28, %Chg: 4.04
20140919, 90.49, %Chg: 1.36
20141017, 83.83, %Chg: -7.36
20141121, 88.96, %Chg: 6.12
20141219, 92.89, %Chg: 4.42
20150116, 95.18, %Chg: 2.47
20150220, 104.55, %Chg: 9.84
20150320, 108.43, %Chg: 3.71
20150417, 106.69, %Chg: -1.60
20150515, 110.30, %Chg: 3.38
20150619, 112.62, %Chg: 2.10
20150717, 118.86, %Chg: 5.54
20150821, 98.84, %Chg: -16.84
20150918, 102.84, %Chg: 4.05
20151016, 108.24, %Chg: 5.25
20151120, 120.07, %Chg: 10.93
20151218, 107.72, %Chg: -10.29
20160115, 93.90, %Chg: -12.83
20160219, 95.01, %Chg: 1.18
20160318, 99.20, %Chg: 4.41
20160415, 98.59, %Chg: -0.61
20160520, 99.78, %Chg: 1.21
20160617, 99.00, %Chg: -0.78
20160715, 99.80, %Chg: 0.81
20160819, 96.39, %Chg: -3.42
20160916, 92.56, %Chg: -3.97
20161021, 93.03, %Chg: 0.51
20161118, 98.24, %Chg: 5.60
20161216, 103.91, %Chg: 5.77
20170120, 107.66, %Chg: 3.61
20170217, 110.06, %Chg: 2.23
20170317, 111.76, %Chg: 1.54
20170421, 114.44, %Chg: 2.40
20170519, 107.52, %Chg: -6.05
20170616, 105.51, %Chg: -1.87
20170721, 107.09, %Chg: 1.50
20170818, 100.70, %Chg: -5.97
20170915, 98.52, %Chg: -2.16
20171020, 99.40, %Chg: 0.89
20171117, 103.44, %Chg: 4.06
20171215, 111.27, %Chg: 7.57
20180119, 110.59, %Chg: -0.61
20180216, 106.53, %Chg: -3.67
20180316, 102.87, %Chg: -3.44
20180420, 100.24, %Chg: -2.56
20180518, 103.93, %Chg: 3.68
20180615, 108.85, %Chg: 4.73
20180720, 111.48, %Chg: 2.42
20180817, 112.48, %Chg: 0.90
20180921, 110.40, %Chg: -1.85
20181019, 118.90, %Chg: 7.70
20181116, 116.19, %Chg: -2.28
20181221, 104.22, %Chg: -10.30
20190118, 111.04, %Chg: 6.54
20190215, 112.59, %Chg: 1.40
20190315, 114.96, %Chg: 2.10
20190418, 132.45, %Chg: 15.21
20190517, 135.04, %Chg: 1.96
20190621, 140.23, %Chg: 3.84

TOTAL MONTHS = 118
DOWN MONTHS = 34
UP MONTHS = 84

%UP MONTHS = 71
AVG %UP MONTH = 4.29

%DOWN MONTHS = 28.8
AVG %DOWN MONTH = -5.1

DROPS >= -8% = 8

 

[Raltin]

Hi Option Attack,

This is good information. However, as you pointed out- this is only showing third Friday to third Friday changes. In our calculations, we are taking rolling periods (30 day/15 Days whatever).

The chart we have is for all 30 day periods.

But - the general idea for us to calculate expected values based on past stock changes is a key input in our methodology.

 

[Option_Attack]

Yes it is very simplistic data. Just a quick way to see how much movement a stock may have month to month, if anyone thought they could get away with just throwing on a condor or whatever every expiry with no adjustments.

 

[ffs1001]

I lost confidence in the original post when I read :
Buy 125 Put ($0) and 155 Call ($0). (Note: The OTM Put & Call Price was zero on June 28th because those options were not traded and even offering a marginally higher price for those OTM strikes should not impact the expected value and ROI calculations by a substantial amount)

....but Option_Attack's data shows some potential.

Has anyone explored this trade idea further? Given that 71% of the months are up, and 29% down, then how about something like a delta positive 1-month iron fly, expiring on the 3rd Fri of each month?
I no longer have access to CMLViz software, otherwise I would be able to model this historically.

 

[Raltin]

Hi FFS1001,

Our software does all the historical modeling and computes the expected value/ROI based on the past price movements. Its similar in principle to what Option_Attack did but we did for all possible 30 day periods (or 7/8 or whatever expiry days depending on the trade) not just Friday to Friday close.

Our software also tracks the profitability of trade post recommendation (see chart below).

 

[ffs1001]

Ratlin,

So the figures in the chart above (eg. 6.3, 6.72 etc) are the values of the iron fly which was opened on 9th Jul for a credit of 9.75? Thus, if the fly was closed on 18-Jul for 6.3, then the profit would be 9.75-6.3 = 3.45?