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
I am going to answer your questions in combination since I think they are related.(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?
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
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
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
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
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
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.
Last edited by so2c; 07-19-2011 at 11:30 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.
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.
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.
Posting Permissions
Reply With Quote