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ernsttanaka
06-02-2011, 03:52 PM
To celebrate this new forum I will post for a month my main bread and butter option trade. For several years I have been trading ATM Butterflies on the Russell 2000. A butterfly is a typical non-directional trade, which allows a trader to accept market risk without expressing a strong bias for a direction. The reward for this trade comes out the decay of the short options.

For July I opened my trade today, by selling a ATM (Iron) Butterfly (770/820/870) for 34.65.
I will publish my trade in a 5 lot - this is a good size to communicate all the aspects of this trade - for reason of privacy I will not disclose the size in which I trade in real life.

The July trade has a risk of 5*100*50 = $25000 minus the premium received $17325, so my total risk is $7675. This the beauty of the trade my risk is defined - an overnight gap and the RUT open on 0 or on 2000. My risk is defined. I will try to work this trade till I earned approx 20% of my risk.
In normal months I might have to adjust this trade a couple of times. Sometimes it is set and forget and at times I will have to bail take my loss and wait for the next month to start again. For me it is essential not lose more than MAX!!! twice what I make in a normal month. But a loss of twice a normal month should be a very exception hit - IMO a combination of personal errors and a though market can only lead to that kind of loss.

So we got the entry, we talked about Risk, we talked about a goal for reward. I will update daily and walk you through the other aspects of this trade.

I know we have some very knowledgeable options traders on this board; Harold, Thannis, Michael. Feel free to chime in as we move along. I am very interested to learn from you insights.


Happy trading

Ernst

so2c
06-03-2011, 01:48 AM
thanks for sharing your experience and looking forward to following and learning from this trade!!

my question at this point would be what's the rule for selecting the border numbers in this case are 770 and 870? (from the charts, looks 870 --> recent top and 770 in Apr--> recent low in Jan).

Also, is there a best entry point, e.g, waiting until RUT comes around middle of two borders (in this case, (870 - 770)/2 + 770 = 830) or when its premium increased? .

I would also like to know additional selecting conditions for iron-butterfly trading candidates, e.g., do we need to find high/high liquidity volatile securities? positioning or avoiding for ERs ? etc.

Thanks!

PX

ernsttanaka
06-03-2011, 09:25 PM
For a option trader, Friday was a unique day; market "hard" down and no move in the VIX. I will show in a minute how that worked out for my trade. But lets start with a basic introduction of the page I copy from my broker platform (ThinkorSwim), since not everyone is with TOS and not everyone trade options on a daily basis.

The page I copy, in this post, is the analyze page. This page is built up in three section. The top section shows the Profit and Loss graph. The middle section shows my position risk expressed in terms of option Greeks. The bottom part show you which options are part of my position.

The P/L section shows the Profit/loss graph for expiration day in red and for the current day (t0) in white.
Tos allows to do "what if" games with the analyze page; what would happen to the graph and P/L if the volatility moves up with x points. What happens when we move time a couple of days. Or combination of those two. At the end of the day just before the close I will run through a couple of those scenarios just to see how my position (in theory) will hold up the next day. If necessary I will make a minor adjustment to compensate for a market running to close to the edge (the expiration Break Evens).

The middle section show the options greeks for today for the current price (live) and if the market would move 1sd up or down. I am going to be brief on greeks, if you need more do a search on Google. In short; Delta and Gamma is the directional risk. Vega is my risk associated with a moving Implied Volatily and Theta is the estimated time decay of one day. Theta is my daily pay check. Today my vega is -304 which says that if the RUT IV moves one point up. I loss $304 and if the RUT IV moves one point down, I will make $304.

Today my delta is -3 which is extremely "flat" no directional risk. Yesterday the delta was -22 which means for every RUT point we go down. I make $22. Gamma is a factor which expresses how the delta of the position is changing. Yesterday the gamma was 1.18. This means in short and with a broad brush. That for the first RUT point down I made $22. For the next rut point down I made $22-1.18. For the 3rd RUT point down I made $22-1.18-1.18. Etc etc. This continues till the delta isn't short anymore and then I will lose the delta in $ per point if we continue down. Gamma is not a stable number it will increase over time and as you see today it also increase when we get closer to the edge of the trade. It is Gamma which makes the T0 graph have a slope.

Today was unique because we went down and the IV was flat. Since I started with a negative delta position and a negative vega position. I gained the "delta profit" and was not punished for an increase in IV. This doesn't happen often but it is the 2nd time this year.

Lets finish up for today with the questions from Px;


1. my question at this point would be what's the rule for selecting the border numbers in this case are 770 and 870? (from the charts, looks 870 --> recent top and 770 in Apr--> recent low in Jan).

2. Also, is there a best entry point, e.g, waiting until RUT comes around middle of two borders (in this case, (870 - 770)/2 + 770 = 830) or when its premium increased? .

3. I would also like to know additional selecting conditions for iron-butterfly trading candidates, e.g., do we need to find high/high liquidity volatile securities? positioning or avoiding for ERs ? etc.

1. I like to look at current ATM implied volatility for the RUT and calculate what the expected move for the RUT is till expiration. Current 42 point up or down. Then I will round up to the next strike. Since this trade only to be active for approx 15-20 days, 50 wide should give me a reasonable safety margin. (Plus there is a plan if we have bigger moves).

2. With hindsight there is of course a optimum entry point. I look for an entry point in the range of 45-30 days before expiration. And as a personal style I like to enter when I (think to) see an intermediate top in a confirmed uptrend. It is not that you can't trade these in other markets - and if I don't find my favorite spot I will enter just based on time. This with the exception when the VIX signals market panic, then I will wait till I see a confirmed downward trend in the vix.

3. Highly liquid, multiple exchanges, electronically traded, broad based indexes. For this "bread and butter" kind of trade only the RUT and NDX count. The spx is open outcry, good to trade in normal market conditions, but during panic hours the SPX pit will not see my complex order and I will get run over by GS and MS. The SOX is not liquid enough and trades only on PhlX, nothing against PHLX, but if one echange has the monopoly of the option price you will see strange things during hours of panic. The rest of the broad based index are disqualified (for me) for similar reasons. For this style of trade I stay away from individual stocks, because I am not interested in carrying the risk of a merger or naked-photo of the CEO on his twitter account.

This is it for the weekend, as said before come out of hiding if you have questions. BTW I am Dutch (and live in NY) so excuse my grammar. I don't have time to reread it tonight, I will correct the most obvious errors tomorrow.

nickola.pazderic
06-05-2011, 12:55 AM
I'm very glad you have taken the risk to show and explain your bread and butter trade.

Pascal
06-05-2011, 03:13 PM
Thank you for posting your option trade Ernst.

This is very useful for those like me who do not trade options very much.


Pascal

senco
06-06-2011, 02:33 AM
Ernst, thank you for sharing this; great opportunity to learn :-)

Could you please clarify regarding your money management:
> I will try to work this trade till I earned approx 20% of my risk.
> For me it is essential not lose more than MAX!!! twice what I make in a normal month.
Is the intention to exit the trade when the profit reaches a target if 20% of $7675 , and bail out when in spite of adjustments one is at a lost of twice as much?

Ken
06-06-2011, 12:22 PM
Hi Ernst,

Base on the setup, as long as price remains inside the triangle, the position will result in net profit by option expiration. What do you find to be the best approach for exiting the position when price starts to move outside the triangle ? Do you just exit all legs of the trade or try to neutralize the total position delta as close to zero as possible until expiration ?

Thanks-
Ken

ernsttanaka
06-06-2011, 05:58 PM
A rotten day for the market and the butterfly gave back a little from Friday's gain.

The position Greeks are within my comfort zone. 32 Delta's long, 2 Gamma's long, Theta of 59 and a vega of 270. A one day, one standard deviation move for the RUT is approx 10 point and a 2SD day is 20 points. So if tomorrow again a down day, we can expect to end in between 32+(10*gamma) and 32+20*(gamma). This is a very rough calculation since gamma is not static and increases when we move to the lower Break even point. For a position this size I start "worrying" about the directional-greeks (delta and gamma) when I get close to 200D long or short. The above rough calculation, with all it errors, shows that in normal circumstance I should be able to sit on my hands. (which can be difficult enough by itself).

The Implied Volatility - burned into my screen by monitoring the vix continuously - is still not signalling a big break in the market. This the main reason I have not (yet) hedge the RUT vega's with a time spread in the RUT. I do have some time spread in other vehicles. So on a portfolio level I have a (small) hedge against the short RUT vega's.
An other reason I haven't hedge the short vega's has to do with the "vertical volatility skew". I leave that topic for now, you can give it some thought, I will get back to that tomorrow.

I close for today by answering the outstanding questions.

Senco -- that is a good summary of my trade-plan. But don't forget that I said twice my profit potential only in situation of severe market stress and personal errors. With an ATM butterfly on the indexes I "play" the odds that this month will show a normal distribution. This is one of things I monitor by checking how big the daily moves are in terms of Standard Deviation. Another thing I monitor is the VIX. If the combination is showing that my axiom proofs to be false then I bail, take my loss and wait for the next month. My experience is that a "normal' loss in a month were it just doesn't work, is closer to 1 times a normal months profit.

BTW my personal errors in this regards are over-trading, anticipating a market direction and not obeying my max loss rules. When you are doing this for several years in the end you will have seen them all :(

Ken, I am kind of hoping not to show you that this month :).
One line of defense is that my initial position is only half of the money I am willing to put at risk. So if we move closer to a break-even - I will contemplate to add an extra ATM butterfly. Another action could be taking of step by step the 770-820 spreads. This reduces the downside risk and normalizes the position greeks. I am more inclined to do the first (adding) when me move to the upside break-even and the latter when we move to the downside break-even.

ernsttanaka
06-07-2011, 08:28 PM
Not much changed in the condition of the trade. I am a bit worried about market action. In the bounce I would have liked to see a bigger spike down in the VIX and of course I could have done without the sell off in the last 30min. All in all the bounce looks suspect.

Getting back to Vertical Volatility Skew and how it affects a butterfly. Attached is the current July RUT SKEW. I will do my best to clarify - it is quite advanced and it took me awhile to figure it out.

Step by step;
- the short vega in my position are coming from the short calls and puts. The long calls and puts have a positive vega but not enough to compensate for the short vega of the short contracts. Hence a overall short vega position.
- So the worry for being short vega in this position needs to concentrate on the short contracts. The long contracts will help me compensate for a increase in IV.
- When the market drops. The skew graph in its entirely is moved upwards, but at the same time moved left because a new point has become at-the-money. Hence my 820 contracts slide down the slope. These two moves, upward and slide, compensate each other at first. Only when the increase in IV is extreme the slide will not be enough to compensate.

All of this is not enough to be casual about the negative Vega in this position. A trader needs to be aware skew-development during the trade and will need to partly off-set (hedge) his short vegas with a time spread. But a full hedge of butterfly vega would be overdone.

I deal with IV on a portfolio level. One of the trades I have is a long SPY Jan13 135 puts rolled from a prior year JAN12 125puts. This position cost me some money but it is a insurance against an overnight drop. Against these puts I will sell front month puts with a delta, using my directional skills to determine timing. Currently I have sold the JUN121 puts for 50ct. I am doing this frequent and reduce the cost of the insurance.

BTW IV Skew is copied from Livevolpro TM

haroldklee
06-08-2011, 11:42 AM
I can confirm that the RUT Butterfly trade Ernst is describing is a versatile and robust one. I've seen him trade it with excellent results over recent years, and have learned a lot from his observations.

As one can see, there's a lot to keep in mind. The Greeks are vitally important, especially Vega, Delta, and Theta, and it's difficult to pick up the intricacies without serious study and experience. This way of trading is an interesting contrast to what's primarily discussed here at Effective Volume. In trading the Robot, for example, most of the intelligence is applied to setting up and calibrating the entry; once in the trade, stops simplify the exit. With this RUT Butterfly, on the other hand, some thought must go into the entry, but most of the skill and analysis occurs afterwards, in making adjustments, offsetting with other simultaneous trades, etc.

I think there can be a profitable synergy in combining the two approaches. Knowing the direction of the market is a great advantage, whether in trading ETFs or options, but this RUT Butterfly allows one to profit from normal retracements and periods of choppiness. With luck, we may see how this is so this month as Ernst describes his trade.

ernsttanaka
06-08-2011, 07:32 PM
We are all waiting for the bounce, which seems not to happen right now and here. The vix spiked (a bit) in the last half hour. In the afternoon the RUT broke out of the day-trade-range. Both not really positive signals.

I was sitting on a small profit. With the jobless number coming out and the position so close to a first adjustment. I decided to pull take the (small) profit and run. $375 with approx $8000 in risk makes 4% in 7 day; not bad for a trade that got quickly into problems.

The decision came in two steps;
On the first graph you see the untouched position (simulated)
On the 2nd graph you see the position with a time-spread 790 Jul/Aug which I added around 1pm.

The time spread was a vega hedge cutting the vega in half. If the bounce had materialized during the afternoon hours, the calendar would not lean (too) negative on the fly. All in all a position which I was willing to hold overnight, till the break in the trading range happened.

Then I decided to pull the (iron) butterfly. It is still 37 days till expiry, so I have at least another week to see how the market develops and to re-enter on a hopefully better stop. So for the time being I am left with a time-spread which you can see on the third graph.

I have to admit that not all the decision making is mathematical. I got my biggest draw last year when QE1 ended I haven't forgotten that experience and I play the end of QE2 extra careful.

ernsttanaka
06-09-2011, 08:21 PM
Yesterday we changed the butterfly into a calendar. A calendar is a lazy man's trade. It doesn't need much attention intra-day. If anyone is interested in trading more with options, I would really recommend starting with calendars. With a proper selection of the underlying and a correct execution, its is relatively easy to bank 10-15% on capital @ risk over a 30-60 day period. In the future I am happy to go more in depth.

During the day I had an order to enter a new fly 750/800/850. I had priced my order sharply, so in the end no-takers, which is okay. I have a couple of days to see how the market develops.

See my current P/L graph below.

ernsttanaka
06-12-2011, 07:59 PM
Lazy weekend, no sensible comments come to mind -- So I leave it with the Analyze

ernsttanaka
06-14-2011, 06:58 AM
I re-entered the iron butterfly centered around the 790. No regrets that I side stepped the market for a couple of days to see how things are developing.

The margin on the butterfly is (5000 * 5) - (3100 * 5) = $9.500. My goal for this trade is 20%.

Let's see how it develops over the next week.

ernsttanaka
06-14-2011, 07:38 PM
Nearly perfect in the center. Greeks for the position are nicely under control. I like to have short delta, especially in a vega negative position. This way if we go down my short delta's and the short vega's will compensate each other (for awhile).

Let's focus today on the size of the move in the RUT in term of a standard deviation. Check Wikipedia for Normal distribution curves, and for the chance that a move is 1 standard deviation and 2 standard deviations.

To calculate the size of the expected move based on the implied volatility you can use the following formula.

Underlying * IV * SQRT(time)

So for today's move in the RUT that is
777 * 22% * SQRT(1/365) = 8.94. The RUT had a 17pnts move, so today was a 2SD move.

For a week that is
777 * 22% * Sqrt(7/365) = 23 pnts

By itself a 2SD move is not a problem for my trade. I get frustrated when they come frequently and especially when they come frequently in the opposite direction.

I finish off with some good sites for option education.

CBOE
Option Industry Council http://www.optionsclearing.com/clearing/industry-services/options-industry-council.jsp

Both have a great education section, with tons of free pdf's and webex's.

ernsttanaka
06-15-2011, 09:50 PM
There are expiration months that by now i am done and can start closing the position. For July that is not the case. The position had a good day. We had a little progress, what considering the market is stellar.

My downside adjustment point is still 20 point away. I should be able to walk away from the computer with an alert to my cell phone 15pnt under today's close. Theta will take care of itself.

I truly hope that none of you got hurt by this enormous chop. With a vix climbing, triple witching on Friday, the end of PoMo, I can only say "Be careful out there, surviving is the most important thing. That way you can play again when this volatile period normalizes"

ernsttanaka
06-16-2011, 07:08 PM
The VIX keeps moving up and by what ever method you use, you will have to conclude it is in a uptrend.

For me a VIX crossing 22.50 is an important point. When we are over 22.50 and I don't see a downtrend I will no longer trade in a "Business as usual mode". I reduce risk and stop entering new positions and necessary adjustments are risk reductions. Check a Long term VIX chart, VIX above 22.50 doesn't happen to often and it tells you some big parties are expecting that "anything" can happen.

For my trade style when the chance that "anything" can happen becomes real, I need to move to the side. My profit goal for the month is no longer valid and not breaking anything because the main goal.

Allow me an anecdote. I am a sailor, I have crossed the Atlantic several times. On time I left solo North Spain, heading for the UK and Holland. 40 hours out, I was hit by a big storm, my first one solo. I was well prepped. Clean, well maintained boat. I reduced the sails, I locked the rudder in a safe setting, closed the hatches, set the Radar Alarm against other ships and went to sleep on the floor of the main cabin. I had a great nearly 8 hrs sleep. The next morning the storm subside and I continued with my journey.

To me that is what a VIX 22.5 is a storm warning, some hit you, some pass by on the horizon, some never show up.

Most of my accounts only have the Fly/Calendar combination and have only 25% (or less) account value committed. So I am in a good spot.

If you check the greeks of the position below; you see the trade being nicely neutral. Again I am in a good spot.

In conclusion; I am alert but not yet alarmed.

ernsttanaka
06-19-2011, 02:10 PM
Just the pic's of the Analyze page - to keep you informed on what goes on the domain of "Non directional trading".

ernsttanaka
06-21-2011, 08:45 AM
If you think boring, you are right non-directional trading is boring in the good months. Just sit and wait for theta to come in.

ernsttanaka
06-22-2011, 08:29 AM
yesterday was painful day. What ever I had already gained, I had to give back. Never a nice thing to do.

I have two graphs. The first is the position as it is, the second graph includes the adjustment I am considering. I am looking at moving 2 call spreads from the 790/840 to the 840/890. The benefit would be a reduction of my delta by approx 50%, while maintaining theta. Both positive, negative would be an increase in Vega and Gamma.

I haven't entered the adjustment yet, by pure objective trade rules (mostly size of delta) I am close or even a little passed that point. I decided to wait for today's open, expecting some weakness before the FOMC.


We will see how today develops.

ernsttanaka
06-22-2011, 06:59 PM
I executed the discussed adjustment around 10AM this morning. I did not expect a run away market to the upside, but I can only allow myself so much room when it comes to delaying my adjustments. The name of my game is not 'correctly predicting market direction', my game is called 'Manage Risk while Theta is doing its work'.

Hence I moved 2 call spreads from 790/840 to 840/890.

In the attached graph you will see the effect on the break evens and the Greeks.

The 2nd graph I attach today shows 4 P/L lines each for 2 days further. So the white line is today, the next one is for Friday, Sunday, Tuesday and Thursday. You can see that the distance between the line become bigger, that is the effect of the acceleration in the decay of the Extrinsic Value (theta).

Completely theoretically I am getting close to my goal next week Thursday.

ernsttanaka
06-23-2011, 07:53 PM
The time spread / calendar part of the trade hit its profit target and I removed it for a nice 20% profit (not taken into account commissions).

In for 9.50, out for 11.40 * 3 times = $570 minus $8 commissions. Not bad for a trade which started of as a hedge for the increase in volatility.

I will give a general tally of P/L when we finish this month.

Below you see the position as it is currently without taken into account the profit from the calendar or from the first butterfly. As said we will add up later.

The plan is to sit on hands during the trading day, and when we have a close beyond 810 or 785'ish to adjust.

The planned upside adjustment is a buy back of the 790/840. Not sure if I will sell extra 840/890 since there is not much money to be made for a lot of risk.

ernsttanaka
06-27-2011, 09:27 PM
Sorry for the hiatus - but I am in California on vacation - with my wife and little baby girl. After hours I try to stay away from this evil eye.

We are still in good condition, the plan is unchanged. I will wait for a close above 810 or under 780 before I will do an adjustment.

A rough tally I kept over all the RUT trades so far (first butterfly and calendar) set me at 3/8 of my $ goal. It is for sure taking a bit longer this month. Let's see how it ends.

ernsttanaka
06-30-2011, 08:28 AM
This is becoming a struggle this month. Taking into account the prior butterlfy and the calendar I am slightly up for the month, but not yet half way my goal.

As always I have two choices; pull the trade and decide that this month was not a good month to play the "normal distribution" odds, or keep fighting.
It is 6:30 AM in California, I am going for a golf game. So I will make up my mind on the 18th hole :)

BTW I adjusted the trade Yesterday morning, by closing out 2 790/840 spreads.

Ken
06-30-2011, 08:17 PM
Thanks for the daily update Ernst. These are really helpful. What are your thoughts on creating butterfly around the range where max pain would fall into since there's tendencies for price pinning near these price points ? This would have to be nailed up perhaps 2 weeks prior to expiration which also is where we have greatest option premium decay. Longer term butterfly/Iron condor appears to work best in slow grind up type market but seems to be a difficult strategy to maintain in volatile market.

Thanks,
Ken

ernsttanaka
07-01-2011, 09:35 AM
Yesterday, I had to make another adjustment. Taking of again a 790/840 spread would have create a (for me) too big an imbalance between the put and the call side. Of course you can put you head in the sand and just keep removing 790/840's but a market which returns south would then really have the potential to hurt. So I preferred to remove a 790/840 in combination with a put spread 740/790. In effect removing a 2 lot Iron condor (see below).

Now I "waiting" for a couple of days of weakness. I am giving the market as much time as I can, expecting that window-dressing @ Q-end will follow by some selling into the long weekend.

To Ken's question - I have been toying in my analyze page with adding a new ATM butterfly on top of this trade. I have been playing that in combination with removing the last of the prior iron butterfly. For so far I have decided to sit and wait. Partly because I am on vacation and have less screen time.

By itself I have nothing against adding a fly here ATM, but I would not place the fly above the market. We already made a big move up, some consolidation would be very normal. The usual aspects come into the equation when you add to a trade; Risk and possible reward. Getting closer to expiration you have to appreciate the risk in Gamma. Gamma is becoming larger closer to expiration and is more factor the daily trade management. Due to gamma you will have bigger swings in daily P/L.

I attached three graphs;
1. my risk graph
2. my adjustment
3. my account page giving you an overview of what I have left in this small 5 lot account.

ernsttanaka
07-02-2011, 08:48 AM
I am flat - I pulled the trade. I will write a wrap up post later this weekend or early next week. Going to enjoy a long weekend in CA before we return to NY on Monday.

Ernst

so2c
07-03-2011, 11:45 PM
Thanks very much for daily updates, which have been very helpful. Volatile market is challenging for any type of trade style and looks like it does make easier for this one.

I'm wondering if more active manage/adjust would make results better (e.g, to maintain delta flat as possible?)

Wish you have a great vocation and Looking forward to your warp-up and more teaching on spread trade tricks (I'm always looking for a lazy man's trade :-).

PX

ernsttanaka
07-08-2011, 12:22 PM
I am going to try to tie it all together.

First let's look at sequence of the trades and I will try to evaluate my decisions.

I started with the trade marked 7 and 8 (sorry for the sequence but that is TOS).
That is my normal monthly butterfly, as said before, I aim for a return of 20% on risk. Trade 7 is some extra long delta which I normally buy to compensate for the negative deltas from an ATM fly. I will try to cut my delta exposure in half by adding some OTM - longs. Quite early in the trade the market stepped down hard, without an enormous raise in the VIX. This allowed me to be profitable in the trade while getting close to the expiration BE's. Since width of the fly is calculated using a standard deviation move till Expiration, getting close to the BE so early in the trade is a red flag.

I first decided to defend the trade with a calendar @ the 790 (trade 9). Intraday the market and sentiment turn further south - So I decided to reduce my risk by taking the fly off (for a profit). In hindsight I have no 2nd thoughts on that decision. Taking a profit, reducing risk in that specific situation was prudent. The only question could be; did I overreact? I answer for myself with no.

The next trade was to re-enter a fly at the new ATM 790 (trade 1). Here I made an judgement error which came to bite me later. I entered that trade without reducing my delta with some extra long. I let myself be guided by an opinion that we would not revisit 840'ish so quickly. When we did, I had to make several adjustment (trade 2, 3 and 4).

In the meantime the calendar hit a 20% profit mark -- an alert fired to warn me -- I took it off @ target (trade 12). No comments on this decision.

Trade 5 and 6 gets me flat and returns a small profit of $150.00

So the question is why stop and why not fight longer. The answer lays in several (im)ponderable facets.
1. it had been a difficult month in comparison to a 'normal' month
2. I had been longer in the trade than normal, and had not much to show for
3. it was a difficult month but I had not burned my fingers.
4. In this 5-lot account I am up over 25% up for the year (25% over account value, not risk). In other accounts the numbers are even better, but there I take more risk (larger fly in comparison to the account size).
5. the closer you get to expiration the larger becomes Gamma and the daily swing in PL can become quite large even in a 5lot trade.

The sequence of my reason above, is the weight I gave to each argument. The first argument weighting the heaviest etc etc.

If and that is a big IF; I had added some extra long to the 2nd fly, that 2nd fly would have been in a better condition when we approached the expiration BE. Argument 2 in my why stop would have fallen away, and I could have given myself some extra time by adding a small new ATM fly or even a small fly a little bit above the market (as Ken suggested in his question). Without these longs I needed to choose between a potentially losing month, a scratch or a profit.

Commissions plays a big roll in this style of trading; my commission's bill is $75 for July.

Overall I am happy with my performance as non-directional trader. For me it is the only trade style which make sense. Of course considering my personality. I have deep respect for Billy and Pascal and the amount of research they do and their ability to stay objective while under pressure. Knowing myself, over time my research becomes sloppy and I will start to see profitable set ups in every bar. Non directional trading allows me to receive payment for market risk, while I don't need to second guess every bar on the chart.


Hope you enjoyed this series into the dark world of "risky" options.

Ernst

EB
07-08-2011, 12:40 PM
Hope you enjoyed this series into the dark world of "risky" options.

Ernst

Indeed. Thanks.

so2c
07-09-2011, 02:52 PM
Thanks again for sharing. It's an impressive performance in a violent whipsaw market.

There are some aspects of trades, which interest me, that you didn't have opportunity to elaborate:

(1). What's the plan /setup if market had a bid move (e.g.,) crash, do you use a stop?
(2). What's the strategy for position size? e.g., when is a setup/good time/market condition to enter 2nd position of trade?

Thanks!

PX

ernsttanaka
07-10-2011, 11:18 AM
(1). What's the plan /setup if market had a bid move (e.g.,) crash, do you use a stop?
(2). What's the strategy for position size? e.g., when is a setup/good time/market condition to enter 2nd position of trade?


I am going to answer your questions in combination since I think they are related.


The (iron)butterfly and the time-spreads (calendar) are risk defined trades. When you enter them you know the maximum exposure. A market gap way beyond nightmares can only create a loss close the the maximum exposure. So in the lazy accounts I have an exposure of approx 20%-25% of my capital. In these accounts total loss is very painful, but it will not get me out of the 'game'. Since only using 25% of the account for this strategy, my average return on risk (20%) becomes 5% per month on account. A total (overnight) market crash will cost me five months of work to get back to the old levels. Again painful but not hopeless for the darkest of all scenarios.

A strongly trending market uni-directional market can be trade with more easily with this strategy, by continuously moving the center of the trade. I keep an eye on the VIX, as explained in an earlier post, when the vix is signaling storm warning, I start reducing risk and every adjustment will get me closer to flat. As long as the VIX is giving me an indication this "transitory" (sorry Sunday morning joke") I am willing to add to my position with a extra fly at the current ATM or centered a bit opportunistically towards the direction of the trend.
To get you to question of timing, that is probably the most difficult part of this trade style, to early hurts the results, as much as too late. You can not let lose get so big that you need to stop by pull the emergency break. As said in an early post before the close of everyday I run some what if scenarios. What if tomorrow we go 2sd up, what if we go 2sd down. What if the VIX spikes a couple of points. Does any of these scenario get me past the point of max loss. If so then I need to act now, because I need to work with the assumption that they could happen tomorrow.
Over time experience (read past errors) will teach you when you can be opportunistic at accept a bit more risk, and when to be careful and reduce your risk strongly.

When the market has big moves in both direction, and we visit both opex break even in a couple of weeks, then this strategy becomes difficult to trade.

You will need to keep book and monitor your P/L closely, since long term success depends strongly on two factors;
1. How many months per year can you make it to work,
2. How much do you give back when it doesn't

In a 'normal' month were this strategy doesn't work you should not lose more than once to max twice your normal intake. In my trading plans I estimate the fly works 10 out of 12 months. I lose in total 3 months of capital in the months it doesn't work, and I have one month of profits going towards commissions. Leaving me with net. 6 months of returns. 6 times 5% is 30% (uncompounded).

The above is description how I look at my lazy accounts. I have one more active account, in this account my risk is bigger, ergo I have more fly and a risk above the max 25%. In this account I own some leap SPY puts. I use to own the 2012 125 put, I rolled them to the 135 when 2013 became available. This a losing position for me, which is okay since it has the function of portfolio insurance. It roughly brings my risk back the desired 25%, while at the same time I am able to trade a larger size fly. In my before the close exercise I will beta weight all my delta towards the SPX and consider my risk on account level.

PX, hope this answers your question,

Ernst

so2c
07-13-2011, 01:13 AM
Thanks for detailed explanations!

Actually I started a small position to practice this strategy yesterday, which qualifies as a sort of "an intermediate top in a confirmed uptrend" entry point somehow.

I did notice that when market moves quickly to lower BE (790), you used a call calendar to compensate Vega, i'm wondering if a put calendar would makes more sense since market trend was primary down at that time?

Thanks again for all the sharing.

PX

ernsttanaka
07-13-2011, 11:24 AM
Derivatives are extremely multi-faceted.

Entering a specialized trade like a butterlfy is dangerous if the trades doesn't have a full understanding of:
every greek and their interaction;
the way volatility is skewed;
the way the skew develops in a normal market, and
how it can effect you when 'shit hits the fan'.

The question about Puts and calls is relevant, but it might indicate that you are at the beginning of your journey into derivatives.
Trading small is essential, but my definition of small and yours can be different. I mean very,very, very small.
And for sure the RUT would not be my first choice. The RUT is a big instrument.

The first step in learning this stuff is to go to the CBOE website. They have tons of free educational webex'es. Those will keep you easily busy for several months. A 2nd step would be deciding if you want a coach/mentor. I had one; personally I would not have survived without, but that is a personal choice. The 3rd step is trading a lot with very small size for 1 to 2 yrs.
We learn by making errors, by evaluation the errors and moving on. If you size doesn't allow you to move on after the error, you throw the baby out with the water. If you can't move on, then the error has become really expensive.

To answer the Put/Call question; when it comes to time-spreads (calendars) there is no difference between calls and puts. The have the same risk graph at T0 and at expiration.

Ernst

so2c
07-14-2011, 02:48 AM
Thanks for the kind adviser.

Actually I'm trading IWM options mimic to RUT, so it's really small amount. The reason I decide to trade a small position is to put my learning into action. I read some option related documents and I feel like I can understand lots of principals and concepts but never was able to learn kind of details that are needed in actually trading.

Back to the question: it seems to me although PUT & Call calendar compensate Vega the same way; but in a down-side biased market, I was thinking Put calendar may give a slight directional advantage, then again this directional thinking maybe should be put-away in such non-directional trading set up.

PX

ernsttanaka
07-15-2011, 07:37 AM
PX,

If you can/want; post your Analyze page from TOS here, I am happy to comment as you move forward with your first butterfly.

Ernst

so2c
07-19-2011, 11:24 PM
Hi Ernst,

Here is my butterfly, any comments are appreciated! (sorry I didn't catch your early comment).

The trade was enter on 7/11 when it comes down from "an intermediate top".

IWM: 2 LOT of 84/90 AUG CALL from 2.15 credit & 84/78 PUT 1.51;l total credit 3.66, total risk of $ 500:

Here is the P/L look like today from original set-up:

I have to say, it works remarkably well with very big up & down regardless on going headline events.

9396

so2c
07-19-2011, 11:43 PM
on 7/18, IWM hit low BE point around 81, I add one calendar AUG/JUL(Wkly)4 81 for 1.34 to compensate elevated Vega, and reduce negative delta (unfortunately, I didn't made a snapshot on yesterday):

Here is how it looks today --> in retrospect, it doesn't look necessarily.
9398

ernsttanaka
07-20-2011, 07:38 AM
A couple of observations;


A calendar is a long vega trade. This means it will benefit from a increasing IV and get hurt by a dropping IV. Adding a calendar when the IV is already elevated is not necessarily a good move, since you will need a continued rising IV to catch the benefit from the long vega part of the trade.
A calendar becomes long vega due to the larger vega of the backmonth. Selecting a weekly/AUG calendar, only gives a little extra vega. My personal selection would have been a AUG/SEP (if at all).

For now I would close the weekly 81 put for 5ct. TOS doesn't charge commission for short option closed for 5ct or less.
Just put the order in, and see if you get a hit, then when next week 81put is trading, I would try to sell those. (if it is at least worthwhile).

Look at the butterlfy, by itself, uncheck the calendar and see how much more there is to gain. For what I see in the clip there is not much reason to stay in the trade any longer. Market up doesn't give an improvement to the PL and market down doesn't have a big improvement either. It seems that you run the course and need to take the profits.

so2c
07-21-2011, 01:10 AM
I closed (prior checking my email -:) the 81 PUT calendar with 3 ct loss on contract (($3) total) since it doesn't seem serve the purpose.

I didn't know TOS doesn't charge for closing short position less than 5 ct. Thanks for the good tip, Ernst.

The calendar adjustment supposes to balance negative Vega & eventually break down below BE point. Now that IWM bounce back from BE point & apparently supported by MA50. So I closed calendar. Should I wait longer? or should turn it a bullish PUT spread/calendar play for a few extra points? I need think these through. For now, I just focused on the Butterfly.

After close the calendar, here is the butterfly P/L: I'm sitting on a 10% profit on risk capital & the delta & vega looks cancel each other, VIX back down below 20.

Next possible moves: (1) wait a little long so Theta yields a bit more; (3) add directional components when market confirm its uptrend; or (3) close the butterfly, lock the profit.

At this point, I'm not sure when to say enough is enough: the max potential is about $500, should I shoot for 25-50% of it? or is this too greedy -:)

So far, I'm happy with the butterfly, which smooth out kind of day-to-day price volatility that could sometimes keep me nervous in a jumpy market like the one we have currently.

9417

ernsttanaka
07-21-2011, 07:06 AM
For me trading a butterfly is about managing risk and not anticipating the market. My biggest problem in this business came from anticipation. I might do smaller trade directional trade when I have a strong opinion and I have to scratch the itch. Often I will do it in an other underlying so not to confuse one trade style with the other.

As for profit goal. Normally that should have been part of your trading plan (made before you enter). For 20% is beautiful level to pull at least part of the trade. In a normal market if the trade is still in good condition. I might scale out in steps. Half around 20% and the rest around 25% and 30%. But in this market I am happy with what I can get quickly and don't push it too hard.

Ernst