Recently, I watched an archived meeting held by a group of active traders. The presenter took a look at the expiration chart and the Greeks of a participant's complex position and could tell that the trader had purchased extra long insurance puts at a specific strike. He knew where those puts were. Can you do that?

Here's our first test, an OEX position.

OEX Complex Trade:

The white square is at the then-current price of the OEX. Any guesses as to what this position is?

It's a calendar, a trade formed by selling a front-month option at one strike and then buying a further-out option at the same strike. What is that strike? You can see that the peak of the tent is a little north of $600 and a little south of $610, so it must be at $605. This particular OEX calendar was formed from selling the JUL 605 call and buying the AUG 605 call, and was priced about a week ago. How do I know it's a call calendar and not a put one? I wouldn't without examining pricing on the option chain more closely. Both types of calendars have the same shape and perform similarly, with some small differences.

But how did I know this was a calendar and not a butterfly, which has a similar-looking tent shape? The curve down to the maximum loss level was the clue. When you have options in different expiration cycles, curves tend to occur.

I know that both types of positions have that tent shape, but a butterfly has sloping straight-line sides, as seen in the following graph. The graph you're about to see is of a butterfly trade formed by selling two JUL12 605 calls and buying wings formed of 1 JUL12 625 call and 1 JUL12 585 call. Note: I probably wouldn't normally trade such a narrow wing size on the OEX, but was trying to recreate a shape as nearly identical to the previous calendar as possible so that the differences on the graph would be emphasized.

OEX Butterfly Trade:

See the difference in the way the sides slope down toward the horizontal segments that mark the maximum losses? Other clues would be available to us if we were looking at the Greeks of the trade. The calendar has positive vega and the butterfly, negative vega. The calendar would not as be appropriate for a time when implied volatilities were very high and expected to come down because it would suffer from what is termed "vol crush." When implied volatilities drop, calendars tend to lose value. Some traders find it hard to manage such a vol crush with a calendar, although some active traders put on calendars month after month as their income trade, through all kinds of conditions, with good results. I am not a trader who does that, however: I just haven't discovered a good knack for handling that vol crush when it comes.

The butterfly can be harder to handle if the volatility is low and expected to rise but I have found it possible to manage that under all but the harshest of declines with the most rapid inflation of implied volatilities. Butterflies can also be hard to handle when there's a relentless upward push.

But what's happened here with the butterfly graph seen previously?

What's Happened on This Graph?

This has the tent shape and straight sloping sides typical of a butterfly, but something is happening on the left-hand side of the graph. The expiration profit-and-loss line slants up in a straight line. Any OEX drops below 550 at expiration result in increasing improvement in profit-and-loss.

Since the profit improves as price drops, this must be a trade with a negative delta. For those not familiar with Greeks, delta measures how much the theoretical value of the position changes with a one-point move in the underlying. A trade with a positive delta would gain money when the price climbed and lose when it dropped. A trade with a negative delta would lose money when the underlying climbed and would gain when it dropped.

Obvious possibilities for that extra option that come to mind are a long put or a put debit spread. Others exist, but these are the most likely first choices. When we think about how the two trades would perform, we know it's not a put debit spread. An example of a put debit spread would be a spread in which we bought a long 550 put and sold a lower put. How do we know? If we'd done that, the expiration profit would have stopped improving at the level of the short put, as the chart below shows.

Butterfly with Downside Protected by a Put Debit Spread:

You can determine from looking at this graph where the downside improvement begins--at 550--and where it levels off--near 530--so you can surmise that this is a +1 JUL 550/-1 JUL 530 put debit spread.

It's kind of silly looking. In order to benefit from this complex trade at expiration, the OEX would have to be between 590 and 620 or else below about 545, give or take a little depending on pricing of the options. You could surmise that the trader who elected such a trade thought that the OEX was likely to stay in a range, but if it didn't, was likely to tumble all the way down to 545 or below.

However, such trades are usually created not with the expiration chart in mind but with the T+0 or "today" chart in mind.

T+0 Chart for Same Trade:

This chart looks a little too directional for a butterfly trade. The debit spread is too wide to be a hedge and is instead a directional bet. If the trader were that sure that the OEX was going to drop that hard, another trade might have been better than this strange combination. However, this combination served its purpose for this article, when we only wanted to illustrate how we can determine where strikes are located and not trade the thing. We could examine a chart and determine what we were seeing and what kind of options probably made up that combination.

Without that debit spread, in a standard butterfly, the T+0 line would have curved down on both sides of the ATM butterfly

T+0 Line for the ATM butterfly Without The Debit Spread:

The trader who feared a sharp downside move might have wanted that overkill debit spread in place.

So, we can see that sometimes what appears to be a strange-looking expiration chart may be an attempt to hedge against a sharp short-term move. We might put together various options combinations so that our T+0 line performs in a certain way. As we grow more experienced with options, those combinations might be a non-standard form of trade that doesn't fit the definition of "butterfly," "iron condor" or "calendar." However, if we know to recognize those shapes on an expiration chart, we know something instinctively about how they'll perform under certain conditions.

We all learn differently. Market makers and specialists don't tend to use the kind of expiration charts that we retail traders like to use. They're looking at spreadsheets of flashing numbers that tell them all they need to know. I like a combination of those Greeks and these charts. I'm learning to ignore the expiration chart in favor of the T=0 chart in my own trades, particularly since I don't keep them open in to expiration week. However, I think all retail traders can learn from studying these types of charts. These have been from freeware OptionsOracle, but some trading platforms provide such information and some subscription sites and others do, too.