Learn how to trade the SPX Weekly Iron Butterfly. This article will give you the basic parameters of the trade so you can incorporate it into your trading plan. Like most other trading strategies, trade management of this SPX Weekly Iron Butterfly is not "set in stone". More on how it is managed will evolve over time as I share trades with you. Again, I want to mention that as with any new strategy, back testing is recommended to be sure this weekly strategy fits your trading style. Start by paper trading before trading it live.
The trade is an Iron Butterfly, with 30 point wide wings on both sides. What is an Iron Butterfly? It can best be described as two vertical credit spreads; a put vertical and a call vertical. The short option is placed at the strike closest to the underlying price (ATM, or At-The-Money). The trade is entered in one order, by selling an Iron Condor. An Iron Butterfly when placed ATM is negative delta. To make the position more neutral delta, I start a little above the money. This gives more protection on the upside if the price of the underlying moves up. This is illustrated in the graph of this week's position at the close on Friday, which is at the end of this article. My personal choice is to avoid any directional bias.
For those of you who may not be familiar with the cycle of weekly options, there is a separate option chain for each week with the exception of the monthly cycle. For the cycle in this article, "the weekly" is the "monthly". Having said that, it is also worth mentioning that the premium on the monthly cycle is usually lower than the weekly cycles because of the decay that has already taken place in the monthly cycle .
The trade is entered Thursday or Friday, depending on market conditions and pending economic news. When the underlying has moved one or more standard deviations on the proposed entry day, you may want to sit on the sidelines. Time of day for entry is a trader's choice. I sometimes look for a bit of a volatility spike by watching the VIX during the day for a slightly better credit. Given the recent intra-day market moves, entering during the last hour of trading is also considered. My goal is to get as close to, or exceed, the optimum 1:1 risk/reward for credit ($15), as explained in last week's article.
Planned maximum capital allocation is $3,000 per contract (width of the wings). In a Reg-T account, your broker will hold the $3,000 (total risk) less credit received, against your buying power. (Example: $3,000 margin less $1,500 credit = $1,500 buying power effect before commissions). Trade is to be exited at a 10% loss (again, based on maximum allocated capital), or $300 per contract. I stress again the importance of risk management, keeping in mind there are 52 weeks in the year to trade. A few losses should not destroy your annual yields if the losses are kept to a minimum. Weekly options trades can move very quickly because of their short duration, so it's necessary to keep a close watch on the position at all times. Of course, in the event of large gaps, there is a possibility that the trade may have to be exited at greater than max loss. This trade is just as vulnerable as any other trade to huge, market-moving events. If such events are known in advance (i.e. fiscal cliff), it's best to sit out that week.
When the market is quiet, it is often tempting to stay in the trade for more than target - my recommendation is, "don't get greedy." I have seen numerous times that profits can fade very, very quickly with little price movement. Remember, there are 52 weeks to trade this strategy, and the key to ongoing success is to take small, consistent gains.
SPX Position Entered Friday, March 8
SPX Weekly Iron Butterfly at Trade Entry
Time of entry: 10:00 Eastern. I suggest waiting out the first 30 minutes after the open. SPX price: $1,543.90 at entry, VIX at 13.27
Call spreads are -1545/+1575
Put spreads -1545/+1515
Credit received $14.60
Maximum margin/risk is $3,000 (width of wings)
Buying power reduction: $1,540 ($3,000 less credit of $1,460). This leaves $1,460 for adjustments.
Adjustment trigger points:
- Upside if SPX reaches 1555: Call spreads will be rolled 20 points
- Downside if SPX reaches 1535: Put spreads will be rolled 20 points
Adjustment will be made in one order; using a Condor Roll of all calls on the upside, or all puts on the downside.
SPX Position at the Close Friday
SPX Weekly Iron Butterfly Position
As you can see from this graph, the price of SPX moved up over 7 points from time of entry to the close (from $1543 to $1551). Due to the amount of time decay that occurs on weekly options on a Friday, the position held up fairly well given the price move.
Closing order is in to close the position for a $13.00 debit, which will be a net gain of $150 after commissions.
Feel free to email me with any questions; an update on this position will be posted Monday. In the next article you will learn about some additional adjustment guidelines.
As always, stay keen on your risk management and trade carefully.