Strategy: Combines Two Vertical Call Trades Entered at
Different Times.
Strategy: 1st Trade: Sell n ATM Puts, ≤ 21 DTE
Buy n OTM Puts, Same Expiry
2nd Trade: Buy n OTM Puts (Same Strike As 1st Long Put), ≤ 14 DTE
Sell n OTM Puts, Higher Strike to Create a Butterfly, Same Expiry
Example:
Price Chart: Unwanted price rally that threatens to defeat a working bear put vertical spread
Current IV%: ≈ 50%
IV Rank: ≈ 50
Trade: Leg an existing bear put vertical into a short put butterfly by overlaying a bull put vertical. This could occur when the trader’s bearish bias is wrong and the price of the underlying security rallies rather than dropping.
Typical Strike Deltas:
Step 1 Short Puts ≈ 0.30 to 0.45
Step 1 Long Puts ≈ −0.45 to −0.55
Step 2 Long Puts ≈ −0.45 to −0.55
Step 2 Short Puts ≈ 0.55 to 0.65
NOTE: Long butterflies that include long wing options and short body options are more popular than short butterfly options. Short call and put butterflies are included for comparison purposes. (See the long call butterfly’s note and table for more information.)
Goals: This trade is used as a maintenance measure in order to offset a substantial loss from a strong price rally that opposes the trader’s initial bearish bias.
Manage: A bull put vertical spread is legged into a failing bear put vertical spread to create a short put butterfly. The intent is to create a defined-risk butterfly to limit the loss potential that exists within the original bear put spread. However, as can quickly be seen on the risk profile, this conversion can be folly, as the short put butterfly now carries a potential loss of approximately $2,800. Therefore, once the resulting risk profile is examined, the trader would likely be better off simply closing the original bear put than legging it into a short put butterfly. Notice that a small profit range does exist either side of $157, but the likelihood of this occurring is small.
Profit: Close losing short positions and sell the long puts when this trade achieves either breakeven or a small profit or suffers a small loss.
Loss: This short put butterfly can potentially lose $2,800. The trader would likely close the original bear put vertical for a loss and move on. DO NOT PERMIT OPTIONS TO EXPIRE ITM!