Using a butterfly as a trade leg

Why use a butterfly as a trade leg?

Using a butterfly as a trade leg is not as crazy as you would think.

What I mean is that normally traders have an idea of a direction in mind and they want to ride that direction as long as they can.  The problem is that sometime markets don’t go in the direction that we think and there is some sort conspiracy against the long calls that we own.  Down goes the stock and a nice wipeout on call premium before the trade is stopped out.

Think of a butterfly as a “stop area”

Using a hedge is nothing new trading and as a trader I want the hedge to cost as little as possible.  Depending on the duration, butterflies can be very efficient for the cost.  I have found that shorter duration flies work better as it is harder for OTM options to really pick up any value.  So say you believe today’s rally but you want to hold a call to Friday, think about short term put butterflies against an upside call.

Call butterflies versus put butterflies

Put butterfly performance tends to be better than call butterfly performance. This is a  very general statement and mostly applies to index and equity options.  Volatility and some commodity options are a different story.  The general rule of a butterfly is a move to the short strike is the most important thing.  The closer the move to expiration the better.  Right now any SPY put fly I look at is 8-10 handles wide for a 2 week hedge, ie 290/280/270.

The Current Tweet Cycle

Right now we are in the upswing on the current Tweet cycle.  Any real progress will probably push up 1% and any sadness will push us down 1%.  Just look at the SPY chart below as that is not rocket science.  Set up the upside trade to make money on a 1% move and use the fly to break even on a 1% draw down.  Trade around the Tweet cycle.

Lots of China Tweets move the SPY about 1%

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