Earlier today I did a Live Butterfly Trade in a webinar for Ally Invest. Below is my 4 Step Risk Management Plan.
Step 1: The Set up: I did the Butterfly in SPX at about 11:25 am central today, Oct 9, with SPX around $2548. I bought 1 2520 Call, Sold 2 2550 Calls, and bought 1 2575 Call. I paid $12.15 Debit or $1215 for the entire trade. My beginning position Greeks are: Deltas -2 Theta 13 and Vega -107. Total Capital and Risk for 1 contract is $1220. The expiration is Oct 27 which is 18 days from expiration. Why did I do this? For monthly Income. How does this trade make money? The short options I sold , they decay quicker than the options I bought. ATM options decay faster than ITM or OTM options.
Step 2: Profit Target and Max Loss: 8-10% Profit. If I make around 8% on this trade this week, that’s about $100. So if I paid $12.15 debit, my goal is to sell this out for around $13.15 Debit. My Max Loss is 10-12% of the cost of the trade. So if I want to exit the trade at 10% loss, that would be about $120. So if the spread goes from $12.15 debit to around $10.95 debit I would enter a closing trade to sell out for 10.95 Credit.
Note: If beginner, don’t need to go to step 3. Can just take off trade for profit or loss from step 2. After you have done 10-15 of these Butterflies, you may consider using step 3 and step 4, a little more advanced risk management techniques.
Step 3: When to Adjust? 2535 on downside and 2560 on the upside.
Step 4: How to Adjust? Upside- Buy 1 Oct 27 2570 Call and Sell 1 Oct 27 2575 Call. Downside- Buy a Put in the Oct 27 Expiration that would reduce my long deltas close to zero.