Transcript Butterfly Trading Strategies part 1 of 3, 2/4/12 John Locke Locke in Your Success, LLC. Know what you want, make it happen! I teach traders.

Butterfly Trading Strategies
part 1 of 3, 2/4/12
John Locke
Locke in Your Success, LLC.
Know what you want, make it happen!
I teach traders how to improve their trading and
become more profitable!
www.lockeinyoursuccess.com
© 2012 Locke in Your Success, LLC.
Disclaimer
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Any information contained in this presentation is for educational purposes
ONLY. Neither Locke In Your Success, LLC, John Locke nor it’s subsidiaries
nor any of their respective officers, employees, representatives, agents or
independent contractors are, in such capacities, licensed financial advisors,
registered investment advisors or registered broker dealers. Neither do they
provide investment nor financial advice nor make investment
recommendations, nor are they in the business of transacting trades. Nothing
in this communication constitutes a solicitation, recommendation, promotion,
endorsement or offer (buy or sell) by Locke In Your Success, LLC, or others
described above, of any particular security, transaction or investment.
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* The risk of loss in trading securities, options, futures and forex can be
substantial. Customers must consider all relevant risk factors, including their
own personal financial situation, before trading. Options involve risk and are
not suitable for all investors. See the Options Disclosure Document:
Characteristics and Risks of Standardized Options, available at
www.lockeinyoursuccess.com
© 2012 Locke in Your Success, LLC.
The “High Probability Iron Condor”
Risk $9000 to make $900….YUCK!
© 2008 Locke in Your Success, LLC.
The “Low Probability Iron Condor”
Risk $7300 to make $2700……Better
© 2008 Locke in Your Success, LLC.
The “Very Low Prob Condor”
or the “Butterfly”
Risk $1500 to make $3600…. Yes!!
© 2008 Locke in Your Success, LLC.
Butterfly Challenge
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Risk reward is great 
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Range stinks 
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How do I take a butterfly which has a
great risk/reward ratio and give it the
same range as the “high probability
iron condor”?
© 2012 Locke in Your Success, LLC.
The Answer
 Method
(M3)
3 Butterfly late 2007
 Method
9 Butterfly early 2008
(Bearish Butterfly)
© 2012 Locke in Your Success, LLC.
Since then….
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The M3 and Bearish Butterfly have been traded
through some of the most volatile markets in
history!
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08 crash, 10 flash crash, 11 crash in Aug
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Record rallies in 09, 10
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Made improvements along the way
© 2012 Locke in Your Success, LLC.
M3 Trade System
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The M3 is a trade that has evolved into a system that I now
use as a learning tool.
The M3 allows traders to learn “proper” position analysis,
position control and decision making processes while trading a
live position, experiencing live execution and maintaining
relative safety in the market place.
The M3 is designed to minimize risk or “not lose money”.
It is not designed to create large monthly profits.
© 2012 Locke in Your Success, LLC.
M3 Trade System
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The M3 can be used as a stand alone trade
system.
As a stand alone system the M3 has historically
produced an average of around 3-5% per
month for most of my students. However past
performance can not predict future results.
I still trade the M3!
© 2012 Locke in Your Success, LLC.
Advantages of the M3
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No searching for stocks.
No need to pick direction.
Can be entered regardless of market conditions
Most adjustments are not urgent
No need to sit in front of the computer all day
Can be in the market, making money from
anywhere in the world, in any time zone, even
while on vacation.
© 2012 Locke in Your Success, LLC.
I can trade while I’m skiing.
© 2012 Locke in Your Success, LLC.
I can trade while I’m at the lake.
© 2012 Locke in Your Success, LLC.
I can trade when I’m jumping off
buildings in Las Vegas.
© 2012 Locke in Your Success, LLC.
I typically check this
trade once a day
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Most of the time I don’t need to do
anything.
The times that I do need to do something, I
can usually put it off.
Only in rare cases would I NEED to jump in
and do something right away.
© 2012 Locke in Your Success, LLC.
M3 does not have “hard” guidelines
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Trading from a rule sheet does not teach you to
become a great trader.
Knowing the concepts of trading as well as how,
why and when to apply those concepts is teaches
you to trade.
The M3 uses concepts instead of a rule sheet.
© 2012 Locke in Your Success, LLC.
Underlying Concept of M3
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Maintain positive Theta, relatively flat Delta, low Gamma and
negative Vega.
More important than the current Greeks are the Greek trends (what
going to happen to the Greeks at any given price point on the
analyze graph, as time goes by)
Use a stock, or stock substitute, with a bearishly positioned options
spread (butterfly) position.
Assess risk daily by analyzing, the Greeks and the Greek Trends and
then adjust the position if needed.
© 2012 Locke in Your Success, LLC.
Typical Entry Position
© 2012 Locke in Your Success, LLC.
Typical Entry Position
© 2012 Locke in Your Success, LLC.
Object
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The object of the game is to keep the
proper balance between the butterfly
and the stock or stock substitute while
maintaining positive Theta, neutral
Delta, low gamma and negative Vega
but most important I want to maintain
favorable Greek Trends in my area of
concern
© 2012 Locke in Your Success, LLC.
Preferred Positioning
© 2012 Locke in Your Success, LLC.
Underlying for examples is RUT
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RUT put butterflies with 50 point wings
Butterflies are hedged with either RUT calls, IWM calls or IWM
stock. We will use RUT calls.
The ratio of the butterflies to stock will vary with butterfly
pricing (or implied volatility)
M3 can be used with other indices and some stocks but wing
width and ratios may vary
© 2012 Locke in Your Success, LLC.
Entry Guidelines
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Entry: Approximately 56 DTE
Butterfly Positioning: Short strikes 20 – 30 points
below underlying
Longs: Purchase sufficient number of deep ITM
long options (or stock) so the opening position is
either flat Delta or leaning slightly in the direction
of your market opinion
© 2012 Locke in Your Success, LLC.
Planned Capital
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“Planned Capital” IS a fixed number that we use to base our risk
management numbers off of and is a reasonable representation of
the maximum amount of capital we are likely to have in the trade
during an average month.
Trades with varying capital cannot be properly managed with profits
and losses based off of a percentage of “whatever is in the trade”
because these trades almost always have substantially more money
in them when they win lose than they do when they win.
“Planned Capital” IS NOT the maximum amount allowed in the trade.
In low volatility months with large price moves or if trading into
expiration, your capital may substantially exceed the planned
amount.
© 2012 Locke in Your Success, LLC.
Risk Management
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Planned Capital: $5,000 - $ 8750 per IWM call
depending on butterfly/call ratio which will vary
with market conditions and underlying/s you are
using
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Target Profit: +10% of planned capital
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Max Loss: -10% of planned capital
© 2012 Locke in Your Success, LLC.
Adjustments
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We are going to use a combination of
techniques including verticals, varying
butterfly to call ratios and moving the
butterflies to maintain desirable
Greeks and Greek trends while
maintaining a reasonable amount of
capital in the trade.
© 2012 Locke in Your Success, LLC.
Desired Greeks
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Desired Greeks will vary depending on position size, the trend
of the Greek we are looking at and the direction of movement
we are concerned about.
Greek management is based off of position size.
Position size is determined from how many IWM calls the
position has. (1 RUT call = 10 IWM calls)
For today position size will be 1 RUT call (10 IWM calls)
© 2012 Locke in Your Success, LLC.
“In General”
The desired Greeks for the position size
of 1 RUT call are…
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Delta: Ideally +/- 50
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Acceptable +50 to (-)100
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Delta may exceed this range with
favorable Gamma trend
© 2012 Locke in Your Success, LLC.
In General
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Gamma: (+) is good / (-) is bad
Unfortunately negative Gamma is a byproduct of Theta
(unless we are naked options which we are not)
The total Gamma number, however, is not as important
as the trend of Gamma. As long as Delta is under
control and Gamma is trending positive in the direction
of concern at a favorable rate, there is no problem.
Gamma trend can be observed with the analyze graph.
© 2012 Locke in Your Success, LLC.
Theta and Vega
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Theta: Positive!!! More is better!!!
BUT, more Theta is better ONLY if Gamma and Gamma trend
are under control. There are times it is favorable to reduce
Theta to mitigate Gamma risk.
Vega: This trade should maintain negative Vega…How much?
When IV is high, especially under conditions when the price is
likely to stabilize, then we want more negative Vega
When IV is low especially when the price is very over bought,
we want “less negative” Vega
© 2012 Locke in Your Success, LLC.