The Web is full of videos about option trading. I'm tentatively making the switch from being a long-time iron condor trader to a butterfly trader, so I'm gathering all the information I can. The other day, I was watching short video by a seasoned butterfly trader. He was explaining how to tell whether the profit showing up on his profit-and-loss chart was correct or way off.

That's just the kind of thing I've written about on these pages with respect to the iron condors. Especially when trading the SPX, the supposed pricing on the far out-of-the-money credit spreads that make up each side of an iron condor can be way off. As I've mentioned in previous articles, an unfilled two-contract order inside the normal bid or ask throws off the mid-price or mark, distorting the supposed profit-and-loss levels in an iron condor. Because the bids and asks are so wide in those options, the distortion can be a big one. Some of my Options 101 articles such as this one discussed how to estimate the correct mid-price for an SPX option. Others have specifically dealt with the credit spreads that make up each side of an iron condor.

I know this trick with iron condors because I've traded them so long. However, when I listened to the experienced butterfly trader talking about how he knew whether the theoretical profit showing up on his profit-and-loss chart was realistic, I had to listen to the presentation more than once to understand. I've been trading options more than a decade now, and I wasn't sure I understood what he was doing the first time through.

Does that mean that I shouldn't be trading butterflies? And, you might ask, how can I have been trading as long as I have been and not have immediately understood his explanations? In fact, how can I presume to write articles and not be able to explain to him the precepts that he was explaining to others?

The truth is that there are always tricks and nuances we pick up when we trade the same trade on the same vehicle month after month. It's also true that there is always something else for us to learn about options, no matter how long we have traded them. I don't trade weekly options, but I talk to other traders who do, and even those who have long traded a particular strategy on a particular underlying find that they have to learn the particulars of how that works when employing weekly options. It's not dumb to not know everything there is to know about options: what's dumb is to plow into new trades thinking we know everything there is to know just because we've traded options for a while.

However, of course I can trade butterflies without knowing everything there is to know about them or about the esoteric elements of butterfly pricing. I don't have to have set up my own spreadsheet to track butterfly prices moment by moment. I don't have to know that I might get an easier fill on a RUT butterfly if I route my order to the ISE exchange. I don't have to know if there's a particular time of day when I'm more likely to get a fill. Those would be good things to know, but I don't have to know them to trade a RUT butterfly. Neither do you.

I know successful iron condor traders who barely have an understanding of delta, wouldn't know a standard deviation if it bit them, and have never rolled implied volatility levels up on simulated trades to see how that would impact their supposed profit or loss. What those traders have and what you need are more basic. You need a clear understanding of how the trade profits and what the maximum risk you can incur would be. You need a plan for how you'll manage the trade if it goes right and if it goes wrong. You must have an understanding of how any planned adjustments you might make would impact the margin in the trade or the total risk if catastrophe occurs. Also important are a level of confidence that you'll exit when you plan says you will and the telephone number of the trading desk at your platform. You need to be able to call if you lose that confidence in the middle of a big move or you lose connection to your platform or the Internet at the worst possible moment. Oh, and please do know when your options expire, whether they settle on Friday morning or Friday afternoon of option expiration week, and whether they're cash settled or settled by delivery of the underlying. Know whether your equity option has earnings before the expiration of the options involved in your trade. Also know if the option you're considering is on an underlying that has dividends and if there's an ex-dividend day coming up that might impact your option trade. I can't tell you how many times traders have not realized that an SPX monthly option (with the exception of the new the SPXPM ones) settles on Friday morning but the OEX options settle on Friday at the close.

When I enter a butterfly trade, I know what my planned profit is, and I determine my planned maximum acceptable loss. If I can't adjust to keep that loss from growing, I plan to exit if that planned maximum loss is hit. These days, I set my planned maximum loss at about what I think my profit will be. If I profit more months than I lose, I should be okay. I know that with an unadjusted butterfly, my risk, my actual maximum loss in case of financial Armageddon, is what I've spent on the butterfly. If I should wake up one morning and markets have crashed or some wonderful development has sent them soaring, I know that's my true risk, not my planned maximum loss. I know that if I'm in good health, well rested, and able to attend to the markets, I can trust myself to adjust when appropriate or take losses if they've reached my pre-set maximum allowable loss. However, I also know that in certain market environments, a gap and huge early run can trap me before I've had a chance to adjust or exit. I know that being called away suddenly to a loved one's bedside severely impedes the ability to attend to a trade in trouble. I know that something as simple as a bad case of the flu could theoretically impede one's ability to employ calm assessment of market behavior. That's why I always want to know the maximum I could lose and not just the maximum I plan to lose. I'm of the firm belief that whatever it is you could lose in a trade, you might very well lose some day despite your best efforts to keep that from happening. I don't think such events are likely to happen often, but I do think they're more possible than most people credit them with being. Twice in my trading life, events have conspired to create losses bigger than any I intended to let happen. Fortunately, I have never been one to put all our financial assets at risk, so no financial ruin occurred, but the emotional impact was difficult.

The relationship of risk (maximum loss, not planned maximum loss) to reward is one reason that I've begun the switchover from iron condors to butterflies, however reluctantly. If I can make the same amount of money with less at risk, I've decided that it makes sense for me to choose the butterfly as my vega-negative trade. This isn't necessarily true for anyone else. I like iron condors. I've had success with them in the past but have struggled with them in the current environment. I don't like jumping from trade to trade, so I've come to this choice over a long period of time. It may work and it may not.

I also know that I know that in this atmosphere of strict adherence to rigid FINRA definitions of certain strategies, my adjustments might more than double the margin my brokerage must withhold. Margin might be withheld on both sides if I make the wings different widths, and my locked-in losses for the adjustment will add to the cost of the trade. Any long calls I or call debit spreads I add to hedge deltas will also add to the margin or buying-power effect. So, even though I haven't traded butterflies as extensively as I have iron condors and I don't know all that experienced butterfly trader knows about them, I do know how much I have to set aside to make adjustments when I begin a butterfly trade. You don't want to open a trade and then not be able to afford to make adjustments, forcing you to take a loss rather than adjust.

I know how I plan to adjust. Some butterfly traders might sell their original butterfly and place a new one at-the-money. Some butterfly traders move some of the sold strikes: some move the spreads that make up a butterfly. Some add butterflies without moving the original, and they add them at different places, according to their preferred guidelines. Some buy extra long calls or puts. Some adjustments work better in some environments: others work better in other environments.

I know the basics and maybe a little more than the basics. It will take me years to learn all the nitty-gritty stuff about butterflies that I knew about iron condors after years of trading them. I'll protect myself and my trading account in the meantime by knowing those basics, adhering to them, and keeping my trading size small as I learn, sizing up gradually. You can do that, too. Those are more important than being able to predict what the price of the butterfly will be at each point. It doesn't have to be so complicated if you stick to those basics.