Transcript SMB’s Options Tribe Meeting

The Heart Friendly
Butterfly
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Please note: Hypothetical computer simulated performance
results are believed to be accurately presented. However,
they are not guaranteed as to accuracy or completeness
and are subject to change without any notice. Hypothetical
or simulated performance results have certain inherent
limitations. Unlike an actual performance record,
simulated results do not represent actual trading. Since,
also, the trades have not actually been executed; the
results may have been under or over compensated for the
impact, if any, of certain market factors such as liquidity,
slippage and commissions. Simulated trading programs in
general are also subject to the fact that they are designed
with the benefit of hindsight. No representation is being
made that any portfolio will, or is likely to achieve profits
or losses similar to those shown. All investments and
trades carry risks.”
HEART FRIENDLY BUTTERFLY
FUNDAMENTALS
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Question: What’s so heart friendly about the
heart friendly butterfly?
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Deltas are heavily under control
throughout the trade.
The maximum permitted loss is very
mild—10% of planned capital.
Performs well in most kinds of
markets—channeling, reasonable
uptrends, reasonable downtrends,
reasonable whipsaws.
The trade design is simple and intuitive.
 If
the market moves too
quickly to the upside the
trade’s P and L can be down
substantially at the adjustment
point.
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We enter the trade 36 days out from options
expiration.
Good idea to wait until 10:30 Eastern Time to
let the market settle down and clear out any
reaction to news events and economic reports
that were earlier reported.
Observe the At-The-Money call of the
expiration that you are trading.
If it is greater than 30%, then do not enter the
trade for that month. These are extreme
market conditions not favorable to this trade.
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Wait for the market to get within 5 points a 25
point strike on the $SPX (best liquidity)
Measure a 29 day one standard deviation move
on the $SPX from that strike.
Round down to the nearest 25 point strike.
Then sell an iron butterfly with the short strikes
at the money and the long strikes at the 25 point
strike arrived at through the above standard
deviation analysis.
Minimum Two Lots
No less than 50 point wings and no greater than
75 points.
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Planned Capital is a function of wing
width.
If the implied volatilities call for the iron
butterfly to have 50 point wings, then
the planned capital is $7,500 per unit.
If the implied volatilities call for the iron
butterfly to have 75 point wings, then
the planned capital is $11,250 per unit.
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The Profit target is set at 50% of the peak of
profitability at seven days before expiration
according to your analytical software.
So there is no fixed percentage target profit. It is
a floating number based upon market conditions
and the exact number of adjustments, realized
gains and realized losses embedded in the trade
at any one time.
The maximum loss on the other hand equals 10%
of planned capital at all times, thus $750 per unit
for 50 point wing trades and $1,125 per unit for
75 point wing trades.
There is one initial downside adjustment
point which is simply the expiration day
breakeven on the downside.
 There are two initial upside adjustment
points they are: 50% between the short
strike and upside expiration day
breakeven AND the upside expiration day
breakeven itself.
 In other words, the upside adjustment
plan is more aggressive than the
downside plan.
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Initial Downside Adjustment: Buy a put side
butterfly, the same number of lots as the original
iron butterfly, transforming the position into an
iron condor.
Initial Upside Adjustments: Buy a half-lot call
side butterfly halfway between the short strikes
of the original iron butterfly and the original
expiration day breakeven. If the market trends
upward further, buy a second half lot butterfly at
the original short strikes of the original iron
butterfly completing the transformation of the
position into an iron condor.
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So the downside adjustment is a single full
“condorization” of the iron butterfly, whereas the
upside adjustment, culminating in a full
condorization, happens in two stages. This is
because of the negative delta nature of iron
butterflies, at the money, initiated five weeks
before expiration. The upside risk must be
controlled more quickly than the downside risk.
Note that one of the long strikes of the adjusting
butterflies always sits on top of the original iron
butterfly short strikes and the short strikes of the
adjusting butterflies sit on top of the original
iron butterfly of the long strikes.
Should the market continue
trending in the direction of the new
short strike, implement a 25 point
roll of the credit spread under
attack to buy additional space for
the market to trend before rest or
reversing.
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We roll the profitable short strike to the
market but roll its associated long up 25
points less, creating a wider credit spread on
the profitable side of the trade.
Simultaneously we roll the long of the
attacked credit spread out 25 points further.
This creates an iron butterfly with 25 point
wider wings than the original trade.
At this final do-or-die point in the
trade, we simply revert to the original
trade rules.
 Apply a butterfly adjustment,
condorizing the trade, at the downside
breakeven point.
 Phase into an upside condor in two
adjustments as per the original trade
procedures.
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How to handle market whipsaws.
Examples of the HFB in extreme market
moves.
Examples of the HFB in flat, channeling
markets.
Scaling out of the trade and milking it for
more profit.