I remember the first time someone told me that he was going to adjust an in-trouble spread on an iron condor by using a butterfly roll. I imagined that it was the magic solution all iron condor traders seek to buying back an in-trouble credit spread and rolling it further out of the way, without locking in an unrealized loss.
It wasn't a magic solution. It was, however, at least a partial solution to a problem that traders encounter when they're trying to roll spreads. That problem is slippage. When you take off an in-trouble spread or complex trade of any type and then place it elsewhere, you're usually going to encounter more slippage than you would if you could roll the spread all in one trade. Slippage occurs for several reasons. One is that while you sometimes can buy and sell at the mid or mark, you often have to pay more than the mid to buy and collect less than the mid to sell. If your adjustment requires you to sell something and then buy something, or vice versa, the opportunity for this type of slippage doubles.
An even greater risk is the price-movement risk that occurs from the time you enter and fill one trade and then enter and fill on the other. It's obvious that such risk could occur while markets are running hard or are emotion driven, but such risk occurs even in quiet markets, especially low-volume trading environments. Especially in emotion-driven markets, you add an extra danger, too, of volatility movements occurring even in the instant between when you place one trade and can upload the next.
I'm considering a switch to butterflies for the negative-vega portion of my portfolio, so I'll use a butterfly to demonstrate how a condor roll or butterfly roll might occur. I'm going to use the Analyze page on TOS. Because I can't find a way to use their back-testing "OnDemand" pricing with a profit-and-loss chart, this hypothetical trade won't be in trouble and wouldn't need to be rolled. I'll just be using the TOS page to demonstrate the orders that can be placed. First, let's look at the butterfly, remembering that it won't be in trouble and wouldn't need to be adjusted.
Sample OEX Butterfly:
Notice that this is an all-put butterfly with 30-point wings.
Sometimes traders will adjust an in-trouble butterfly by "condorizing" it, as Dan Sheridan of CBOE webinar fame terms the adjustment. The original, traditional butterfly trade can be broken into two spread components: the +1 630 MAR12 put/-1 600 MAR12 put spread and the -600 MAR12 put/+570 MAR12 put spread. Let's imagine that we're going to roll that top spread from the 600/630 to a 630/660 spread. Here's how you could accomplish that goal in a single order by using a second butterfly order.
Rolling the Spread with a Butterfly Roll:
What has been accomplished by the butterfly order? Let's use a little math to show original butterfly + second butterfly = what strikes left over? (+1 570 -2 600 +1 630) + (+1 600 -2 630 +1 660) = +1 570 -1 600 -1 630 + 1 660. You have a "condorized" butterfly with the central strikes spread apart. You again have two spreads, but this time, they have different sold strikes. The sold strikes are at 600 and 630, and you have 30-point spreads on each side.
You wouldn't ordinarily have adjusted a butterfly at this point, of course. You would typically perform a roll like this as a possible adjustment when the underlying had been climbing and "today" line was sloping sharply downward toward your planned maximum loss. The cause of that sharply sloping today line would have been the delta, which would typically be growing ever more negative. This particular adjustment simulated here raises delta, as can be seen, although its effect would be different if accomplished days later when prices had already risen sharply. Notice, though, that the delta here has risen to 21.05 from the prior -1.90.
Also notice, however, that this adjustment costs money and therefore increases the money you have tied up in the trade. FINRA definitions of a butterfly mean that the buying-power effect or margin you have withheld doesn't always show what you truly have at risk, particularly if you decide to create a different spread width on the top and the bottom. Please always keep plenty of money available for butterfly adjustments due to the odd requirements these days on many brokerage platforms. I keep at least three times what my original butterfly cost, and I know of traders who keep more. I have also heard from traders who can't make the adjustment they want to make because they don't have enough buying power left over to do so.
Often more money is withheld than is actually at risk. You can find out how much you truly have at risk in a butterly on TOS's Analyze page if you follow these tips: Each time you make a trade and it's filled, click on "Analyze Duplicate Trade" from the Monitor page. That trade will be transferred to your Analyze page. Just under the "Price Slices" band, you'll find the "Positions and Simulated Trades" band. Where it says "Show All," click on the pulldown menu and choose "Hide Positions." This lets you follow the trade with all your simulated trades, showing locked in losses and gains from the adjustments. Remember on TOS that you'll want to add in your commissions or click on the pulldown menu at the top of the page under "commissions," and choose "Include" instead of the default "Exclude" if you want to see the actual losses and gains, including the commissions. Your expiration graph, the red line on TOS's Analyze page, now will show your maximum possible loss if you follow the red line to its lowest point on the graph.
Following that red expiration-line graph on the simulated position in this article, you can see that you'll be risking right at $2,000 (the cost of the two trades) for the original plus the adjustment.
Imagine that you want a different adjustment. Instead of rolling the -600 MAR12 put/+630 MAR12 put spread as far out as you did in the previous trade, you want to roll it only to the -620 MAR12 put/+650 MAR12 put spread, 10 points lower than in the first adjustment. In the first adjustment, we were "stepping on" both the 600 and 630 strikes that we already had, moving the 600 to the 630 and the 630 to the 660, so we could use a butterfly roll. This time, though, we'll need the condor roll. I've unchecked the butterfly roll just shown and added a condor roll.
Original Butterfly Plus Condor Roll
We can do the same math we did before to see the resulting position: +1 570 -2 600 + 1 630 +1 600 -1 620 -1 630 +1 650 = +1 570 -1 600 -1 620 +1 650. We have a new condorized position with two spreads. We didn't roll the wings as far out, so the delta change wasn't as significant. In this instance, we needed a condor roll to achieve what we wanted to do in one trade.
Such trades can be used on iron condors. For example, butterfly rolls can move a call credit spread up so that the sold strike is bought back, the previous long strike is now the location of the new sold strike and there's a new long strike further away. It can be an equal distance from the sold strike as it was in the original (for example, ten points away, in what was originally a ten-point spread), in which case you'll be buying a traditional butterfly. The new long can be closer or further away (for example, five points or fifteen points), in which case you'll be buying what Sheridan and others call a broken-wing butterfly.
It's not always possible to get a fill on a complex options trade. Using a butterfly roll or condor roll doesn't always work. When you absolutely have to get filled on an adjustment right away--your wife has gone into labor and you need to get to the hospital and the markets happen to be moving big, for example--you may not have time to patiently plumb around for a good price for your butterfly or condor roll. You may have to accept the slippage that you might incur just to get out. Or you may elect to stabilize the trade some other way until you can better tend to it. However, this is a good trick for your trading arsenal to help avoid paying more in slippage than you might otherwise. It doesn't eliminate slippage, but it does help minimize it in many cases, and it certainly eliminates the possibility that markets will reverse between the time you fill one order and fill the next.