Week 36: How to Trade the Iron Butterfly in your small account

Mcdadds
Mcdadds
Feb 14, 2019 · 6 min read

Good Morning, good evening and good night! How has everyone been doing today?! I’ve been busy with life and haven’t been able to write as much. How are things going? Let me be honest and say, my trading has been getting better since the ending of last year, although results haven’t shown up yet! LOL

Check out the music and videos on trading for small accounts here.

C&S- $2514.06

This is compared to the previous weeks C&S numbers, which was 2259.58. I only opened one trade for this week, and it looks like my beta weight has been coming along in the right direction. Although my beta weight for the portfolio is good, my profit/loss diagram is UGLY. The problem is that I don’t have my profit targets hovering around the $spy and 1st std deviation prices.

Guess what we’re talking about today?! Iron Flies, or Iron butterfly trades. I want to go thru the mechanics on how to build the trade properly, adjusting the trade when it goes south, and other caveats that will help decide whether or not to use this strategy.

Opening Trades

$AMD

The only trade opened for this week, a put credit spread. I placed this trade on 9/6 hoping to ride the wave up, as the chart looked like it was continuing a nice run. I got lucky and got in at the right time as it reached its highest price, $34.14, approximately 7 days later.

Yahoo AMD chart

Closing Trades

This was a week 34 trade, with it being placed on 8/21. At the time, the Q’s seemed to be trading in a consistent pattern. It was trading in a $10 range, with the top being at $187, and the bottom being $175.

The call side of the iron condor was made of selling the 184-strike calls while buying the 185-strike calls

The put side consisted of selling the 174-strike puts and buying the 173-strike puts. I sold two of these for ~$0.31 per spread. I bought back these back for $0.12 per iron condor.

$NKE

Originally made on 8/7. The calendar spread was made at the 80-strike price. If you remember correctly, we sell the front month contract while buying the back month contract at the same strike price. I originally bought the trade for $1.30, while selling it back to the market for $1.75. My thinking was that I needed some bullish exposure, and it looked like $NKE was on the rise up. Fortunately, I was right with the trade, as $NKE climbed higher, fell briefly, and then landed right at 80.

Iron Butterflies-The Mechanics of the Strategy

Iron butterflies, what are they exactly? Well, you can consider an iron butterfly a straddle with protection wings on either side. First, you sell:

1 OTM Call

1 ATM Call(same strike)

1 ATM Put(same strike)

1 OTM Put

The two inside or ATM strikes, will be your straddle strikes, while the OTM Put and Call will be the protection wings. The P/L diagram looks something like this:

The break-even points are:

(Strike price of ATM put) — (credit received)

(Strike price ATM call) + (credit received)

Why Would We Use These?

These are very similar to Iron condor trades, where we want to pin a stock within a certain price range. Maybe a trader believes the stock is going to stay within a 2-point range, and the stock has been having high volatility with option pricing.

With believing the stock may stay range-bound at a certain price, a trader may want to use as little capital as possible for a trade, but also wanting to add a delta neutral position. As compared to the iron condor, the butterfly can be less capital intensive.

These trades are best used in HIGH volatility environment, and are considered a more aggressive options selling strategy. If using this in a medium or low volatility environment, it can lead to disaster, with the trade ballooning up with volatility and making the trade more expensive.

Dependent upon how wide your break-even points are while building the trade, can make this type of trade similar to the iron condor strategy. However, here are some interesting differences between the two:

Of the five bullet points above, the credit received, BP effect, winning percentages are something worth discussing.

Credit Received

The credit received with iron flies are much higher than taking in a an iron condor credit. Why? It’s based off the mechanics of the trade. The iron fly is a straddle with protection wings, usually straddles take in higher credits, however, with lower win rates. Compared to the iron condor, which is two credit spreads both below and above the stock price, making the trader take in a lower credit, but have a higher chance of success.

BP Effect(Buying Power effect)

Now, the best part about Iron butterflies is the cost to hold the trade. Depending upon the strikes chosen by the trader, these can give the trade a better benefit of low holding cost. Now, just because the cost of the trade is low, does NOT mean that’s your max loss. I’ve made the mistake before thinking that, so don’t be a rookie and make that same mistake!

Winning Percentage

This may make the trader think twice of using an iron condor vs an iron fly. The iron fly strategy wins less often than the iron condor, making it more profitable, but having less wins(ARGH)! Why does it win less often? My guess is that the stock price has be very close to the ATM strikes, which it makes less profitable, and harder to win.

Adjusting Iron Butterfly Trades

Just like the other strategies with both a call and put side, we don’t close out of the challenged side. We close out of the uncontested side, and roll up the call or puts for more of a credit. For example, If the Iron butterfly is moving against you, continuing to move up towards the protection calls, do not compound the loss and close out of call protection leg. Instead, the trader would go to the puts side of the trade, close out of the current OTM put and sell a put right below the ATM strike.

Thoughts

The Iron butterfly is a great delta neutral strategy, giving traders a great return on capital, but lower chance of success. Make sure to compare the cost basis between using the iron condor vs using the iron fly. Remember, the Iron fly doesn’t have as much room for error as the iron condor, making it a harder strategy for a good return.

My beta-weight ended up being 0.28, much better since I got out of those $NKE calendar spreads. However, my profit-loss diagram still looks ugly. My way of attacking this is by selling a few more iron condors, and hopefully have my P/L curve cover more of the higher side of the $SPY.

Quick Question: What would you like for me to talk about? I’m more focused on the smaller account guys, as that’s how I’m going to find my trade pattern.

If you have anything you want for me to talk about, please feel free to comment below or email me! I really want to focus on building my smaller account, and people trying to build their smaller accounts.

Please follow the Twitter page here for some trades I like to share. Follow us here on Pinterest page here for just some pics from the blog post, or maybe a new pic( I really enjoy editing and cropping pictures).


Originally published at https://optionselling.net

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