Short-Term Iron Butterfly

An abbreviated post from our forum:

Hi everyone,

This is something I have been trying for a bit that seems to be working pretty well. The idea is to sell an ATM iron butterfly (iron condor where the short strikes are the same for the call and the put spread) using weekly options. I open the trade on Thursday, when the options start trading so we are talking about 8 days to expiration.

The idea is to sell ATM with a 30-point wings. The desired credit is between $18 and $20. Once the order is filled I place a GTC order to close for a gain of $1.50-$2.00. If the target is hit, I want out, end of story.

The bad scenario for this trade is what happened a couple of weeks ago (fortunately I had no position): Place the trade and get a large rally on the same Thursday, followed by another large rally on Friday. I did not trade that week. To avoid this scenario I decided not to trade the first Thursday of the month when the jobs report comes out.

The trade for this week was opened on 5/30 at 11:36 am EST and is:

    Sold an SPX 1625/1655/1685 (1625/1655P, 1655/1685C) for $20.20 credit. I put in an order to close for an $18.20 debit.

By the end of day the position is quoted for $19.50 so it is almost half way there.

I will leave contingency plans (in case SPX moves too close to one strike) to each of you.

Like I said, I think best might be to just close on Friday regardless, but another option is to roll down the threatened side when it moves XX points (or whatever makes sense for you) from the short strikes turning it into a regular IC. Credit collected is high so you will still have credit left, but that will mean waiting longer if you want to exit with a profit.

sharp cocoa

This play seems interesting and worth following.
However, we should take a look at equivalent positions because we never know what insights we could gain from doing so.

Instead of looking at the position as the iron butterfly, let’s break it into two positions: we sold one put spread (1625/1655) and one call spread (1655/1685).

In turn each of those 30-point spreads is divided into three 10-point spreads

    a) Short put spread
    Long 1 SPX Jun 06 ’13 1625 put
    Short 1 SPX Jun 06 ’13 1635 put

    b) Short put spread
    Long 1 SPX Jun 06 ’13 1635 put
    Short 2 SPX Jun 06 ’13 1645 put

    c) Short put spread
    Long 1 SPX Jun 06 ’13 1645 put
    Short 1 SPX Jun 06 ’13 1655 put

    d) Short call spread
    Long 1 SPX Jun 06 ’13 1665 call
    Short 1 SPX Jun 06 ’13 1655 call

    e) Short call spread
    Long 1 SPX Jun 06 ’13 1675 call
    Short 1 SPX Jun 06 ’13 1665 call

    f) Short call spread
    Long 1 SPX Jun 06 ’13 1685 call
    Short 1 SPX Jun 06 ’13 1675 call

Third, we can pair these spreads to produce two iron condors and one iron butterfly.

We can pair any call spread with any put spreads. For our example, I’ve paired the two spreads that are farthest from the middle strike, and the two closest. That leaves the middle two as the third pair.

The Position for Risk Management Purposes

Iron condors

    a) 1625/1635P//1675/1685C

    b) 1635/1645P//1665/1675P

    Iron Butterfly
    c) 1645/1655P//1655/1665

    We own each of these positions and collected a credit of $20.20

I find this easier to manage. However, sharp plans for a quick exit, taking the nice profit and hopefully avoiding risk-management decisions.

When I look at the tree positions, I see one IC that is 20 points OTM and other that is 10 points OTM. The third position is equivalent to owning the 10-point ATM butterfly.

All these positions do well as the market is unchanged and the target is to pay a total of $18.20 (or less) to exit each – again by the target exit date of Friday, one day after making the trade. Thus, we hope sharp has already exited by the time this is published (and he did close the trade, earning $1.75).

Something different

Lets say the market moves away from the center and reaches 1675 (or 1655). We would now have one ATM IC, another that is only 10-points ATM, and even worse, a 10-point iron butterfly that has reached the ‘point of maximum loss if SPX is priced here at expiration’ range. Scary stuff.

The thought of looking to take profits here would not occur to most traders – for the simple reason that the position is underwater AND at risk.

However, the aggressive trade could consider covering the far OTM call spread from one or both iron condors. Because they are weekly options, the cost should be small. Small enough to pay it? Ah. That’s the difficult decision.

Looking at these synthetic equivalent positions, it seems to me that there is no need to go there in this instance. Looking for the quick profit from the iron butterfly seems to be a viable strategy.

One Response to “Short-Term Iron Butterfly”

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