Remember the first time you found out a friend had betrayed you or held radically different views about something important to you? Such first discoveries were often deal-breakers and sometimes heart-breakers as far as the friendships were concerned.
Later, as you grew older, you learned that such disappointments needn't always be deal-breakers when the relationships were concerned. Perhaps you learned that an old friend could still be your best pal when you planned a hiking trip. She was the kind of person who laughed off a sudden rainstorm that drenched you. However, you also learned that you didn't want to confess family secrets around the campfire that evening. She also readily shared everything you'd told her as soon as you got back to civilization.
Profit-and-loss charts can be like that. Before the close on May 1, I adjusted my butterfly trade by adding another call debit spread. This has the effect of raising the delta. Those who aren't much interested in the Greeks of a trade might not be interested in the rest of this paragraph, either, but can still benefit from the discussion of the charts below. Previous additional call debit spreads had changed the shape of the butterfly's expiration chart, giving it a split-strike or almost iron-condor-shaped appearance. One of my goals had been to end up with delta still slightly negative, my preference in vega-negative trades, and widen out the upside expiration breakeven a bit.
My primary goal had been to flatten the T+0 line so that I could endure a big gap the next morning in either direction without any significant loss. I did that, ending up with a delta of about -9, a relatively flat delta for my 5-lot butterfly trade.
Immediately after the close, while I was still making notes and snapping charts for my trade journal, I noticed that the delta had flipped in that few minutes since the close and was about +13. That flip was important because it made the left side of my chart, the side that showed what happened if the RUT continued the afternoon's pullback, look worse.
By the next morning, futures were lower and the disappointing ADP drove them even lower. At that point, my profit-and-loss chart looked as shown below. The red tent-shaped line is the profit-and-loss line at expiration. The white line that is harder to spot marks theoretical profit or loss on any particular day.
Before the Open:
The delta was still showing positive, in the line marked "Live," at +6.53. Futures at that time were down 5.10, so I set up a "slice," as they're called on think-or-swim, to show what the trade supposedly would look like if the RUT dropped to 810.79. That was 5.10 points below the "Live" 815.89. The cash markets weren't open yet, so that price wasn't actually the live or real price. It was the price at the previous day's close.
That slice showed that if the RUT dropped to 810.79, the delta would theoretically rise to 17.43, as is visible on the line where the "Stk Price" is locked at 810.79. Profit (not including commissions) would theoretically drop to $673.85 from the current theoretical $734.16.
I locked in that slice for the purposes of this article, so I could test out what we would really see if the RUT dropped that far. We'll follow it through. The discussions can get a little complicated when I'm making comparisons between "Live" prices before the open, actual "Live" or real prices after the RUT is trading, and "slice" prices, but bear with it. I wanted to demonstrate how much we can or cannot rely on the charts.
For my own purposes, I knew better than to believe the before-the-open "Live" delta or profit. How did I know better? I knew from experience and research that at and shortly after the close and again at and shortly before the open, market makers and options traders are squaring up their positions. Market makers are assessing their risk, changing some pricing according to where they think markets are going. In other words, a lot of the anticipated move was likely already priced in.
In addition, this particular RUT trade is also hedged with deep in-the-money IWM longs. The trade is beta weighted against the RUT. IWM trades in the premarket session, and the IWM shares were lower on this particular day. The RUT, of course, wasn't being computed before the open, so the benefit of the RUT prices dropping closer to the sweet spot in the butterfly wasn't being seen while the detrimental effect of the DITM long IWM calls was being priced in.
Another reason not to trust what I was seeing pre-market was that an increase in implied volatilities would surely result on the open as that almost always happens. It would be even more likely if the RUT dropped to the level of that locked-in slice.
Two minutes after the open, the RUT dropped to within pennies of that 810.79 level.
Two Minutes after the Open:
Now that the RUT's price had dropped to the projected level, were the "Live" Greeks closer to the projected levels at that locked-in slice pre-market (17.43 for the delta and $673.85 for the profit) or what was showing up as "Live" pre-market (6.53 for the delta and $734.16 for the profit)?
Comparing the Greeks and projected profit, we can see that the once the price was closely approached, the "Live" premarket levels of 6.53 for the delta and $734.16 for the profit were actually the closest to what they would be once the RUT actually dropped. Why? Even though the price at the previous day's close was listed as the live price at that time, the Greeks and projected profit were already where the MM's projected that price would go based on futures' action. The match wasn't exact, particularly since implied volatilities can only be estimated. We options traders do have some impact with our supply and demand choices.
Likely, if that price were hit later in the day, the values would be much different, and in fact they did a lot of jumping around. The point here is that such charts are helpful but not perfect. Such projections and their ability to help you hedge against possible movements are helpful, too, but know when to trust what you're seeing and when not to trust it. When you're trading a new trade, as I am, it may be harder to know when you can trust what you're seeing. That's a reason to go in with small lots until you are familiar with the trade. When I was trading my full allotment of iron condors over many years' time, I often traded at least 100 contracts/month. Now, in this actual trade, since closed out for a profit, I was trading a 5-lot of this butterfly, having sized up from my original 3-lots three months ago! I will size up only gradually, if I think I'm managing the trade effectively and it continues to fit my trading style.
Another take-away is that market makers are in the business to manage their own risk, just as you should be in the business to manage yours. I find that Greeks and profit/loss projections prove untrustworthy in the last few minutes of trading, so I like to adjust at least 30 minutes before the close. In this particular trade, I try to adjust just once a day. That practice wouldn't have necessarily been a wise choice when I was trading 100 contracts of iron condors, so those decisions are trade dependent.
Also, if you're a pure directional day-trader type, there's a lesson for you here, too. The projected move is often priced in before the open. It's the business of market makers to do that, and they have more experience with doing that than you or I have. You may be good at technical analysis, and you may jump on a call or put trade at the open, and the underlying may go exactly where you thought it would go. Still, after you pay commissions both ways, you may make little or nothing or even end up paying money. Options pricing may not be a trustworthy friend at that time, but may function more like the friend who knows you're about to apply for a lucrative job and front-runs you to apply for it herself.
This effect doesn't always occur. In my daytrading days, I did make money in some early morning trades. I also sometimes failed to make the money I thought I should be making.