If you're a day trader, your end-of-the-day routine includes closing out all your trades and either licking your wounds or celebrating. If you're in weekly or monthly trades, your end-of-day routine ought to include examining what could happen on a gap move or strong price move early the next morning.

The first couple of weeks of July, I set up several paper butterfly trades, tinkering with my entry times to see if the time of entry impacted the cost of the trade. Let's pretend that one of those butterfly setups was a live trade and that I needed to evaluate it the end of the day on Tuesday, July 9. The next day, the FOMC minutes would be released in the afternoon, and it was possible that any overnight developments might start the indices moving early in the morning. What if there was a gap the next morning?

Position Thirty Minutes before Close on 7/9, Chart by OptionNet Explorer:

Price is right at the edge of the tent shape of the simulated 10-butterfly position. The move on July 9 has been almost a 1-standard deviation move to the upside, with a one-standard range from the previous day's close outlined by the dark blue column. Deltas are a rather flat 6.45 for this 10-contract position. The light blue "today" line also shows the effect of the flat deltas.

Price action toward the downside shouldn't hurt the profit over a short distance, at least. Thanks to an upside hedge (call debit spreads, in this case), the profit won't be hurt too much by a big move to the upside, either. The trader who adjusts butterflies when price reaches the edge of the tent would likely want to move at least some of the butterflies that July 9 afternoon, but the trader who watches the Greeks of the trades might not see any reason to adjust until after she saw how the FOMC minutes impacted prices the next day.

Or maybe she should be looking at more than this chart at the end of the day?

Same Position, Time Rolled Forward a Day and Implied Volatility Rolled Higher:

If disturbing news had come out of China overnight or a major U.S. company had lowered guidance early July 10, a gap down might have resulted. This charting service I use computed the combined implied volatilities for the AUG13 option chain at 16.90 percent late on July 9, but it could easily have jumped to 22.90 the next morning on a severe jolt to international markets and a resultant gap lower when our markets opened.

If prices had gapped lower by one standard deviation at the open under these conditions, the dark blue column tells us that the RUT would have gapped to about 1005.90. The theoretical loss to the position would have been about $2,318 or 7 percent of the $33,471.00 max margin in the trade. Should the trader pondering that possibility on the end of the day on July 9 have made some adjustment to accommodate that possibility?

That would have been up to the trader and that trader's guidelines, but I wouldn't have done anything. A gap lower would have brought price back inside the tent of the butterfly trade, which is not a bad thing. The only way to protect against rising implied volatilities is to buy vols, either through buying an extra long put or something like a calendar trade added to the butterfly trade. However, some choices might have put the trade in worse position if prices continued higher the next day instead. If I'd had a strong belief that the RUT was going to crater, I perhaps might have wanted to do something like that. However, I try not to position these trades directionally but rather to keep risk rather flat. Also, I already had an extra long put that I always add at the inception of the trade, and I know from experience that extra OTM put tends to inflate in value a little faster than this chart shows because of the shape of the skew when prices are cratering. Also, a 7-percent loss is well within my guidelines. Barring an Armageddon-type gap lower the next morning, I would have time to watch the behavior and then make appropriate adjustments.

What if there were a gap to the upside?

Chart Rolled Forward a Day, No Change to Implied Volatilities:

When equity-related securities climb, implied volatilities tend to drop. A drop in implied volatilities helps butterfly positions. Why didn't I drop the implied volatilities in this scenario, when I was determining what would happen with a gap higher? Implied volatilities were already rather low, approaching a support level from which they often bounced. In addition, the important FOMC minutes might keep implied volatilities from dropping ahead of the important afternoon release, even on an up move.

Again, the trade likely wouldn't suffer too much on a one-standard deviation gap the next morning. In fact, it didn't look as if it would suffer at all. However, it was going to get more and more expensive to move butterflies, the longer the price is out of the tent, so the trader's own pre-planned adjustment goals should factor into whether those butterflies should be moved that afternoon or whether perhaps the 970/1020 portion of these butterflies should be condor-rolled higher.

Looking at an Adjustment, Moving Half the Flies to a 1000 Center Strike:

The blue tent shows the trade as it was currently constructed. The green tent and green "today" line show how the trade might perform if half the flies were moved from the 970 center strike to the 1000 center strike that afternoon.

Which was the best choice, just keeping the trade as it was or going ahead and moving at least half the flies? Each has its pros and cons, depending on the trader's preferred way of managing butterflies as well as the market conditions and the trader's outlook on what might happen the next day. This was an iffy case. With more than 30 days to expiration and because my trade includes an upside hedge rather than just the butterfly, I normally would have let the trade venture out of the tent the next day since the deltas were so flat. I would likely have made my decision the next day after the FOMC meeting as to whether to move flies, depending on how the market reacted. Note that I would not suggest this tactic if the trade were the standard butterfly trade with no upside hedge.

If this had occurred two weeks before expiration, I definitely would have moved the flies the afternoon of July 9. However, there was no right or wrong in this iffy case. I elected not to move flies in this simulated case, but who knows? If this had been a live trade, I might have moved at least a few since the case wasn't clear cut.

Day traders can skip this kind of work, but the rest of us better know how much damage can be done the next morning on a gap or a strong early move that happens too fast to adjust. This kind of looking ahead can be done on most brokerage platforms, too. Although some have clunkier analytics than this, most allow you to roll the time forward a day and also tinker with the implied volatilities.

I wanted to note that some active traders have been noticing that think-or-swim's position delta calculations are a bit more positive than some other platforms. In other words, my trade that shows a flattish and slightly positive delta might actually have shown up with a negative and perhaps a much more negative delta on another platform. I'm getting my feed for OptionNet Explorer from think-or-swim, so the perceived delta problem would be showing up there, too, since it's calculated from TOS's feed. I compensate by keeping my deltas slightly positive, although normally I would want them slightly negative in a butterfly trade. I've done some backtesting and that's what feels right for me. OptionNet Explorer allows traders to get their feed from a few other platforms. Freeware OptionsOracle also allows traders to test these EOD kind of adjustments, using feed from various sources, but their data is delayed with some feeds, at least.