2013/08/20 Introduction to the Weekly Short Butterfly. Jeff Augen 2013/08/20

Transcription

1 2013/08/20 Introduction to the Weekly Short Butterfly Jeff Augen 2013/08/20

2 6.Please note: Hypothetical computer simulated performance results are believed to be accurately presented. However, they are not guaranteed as to accuracy or completeness and are subject to change without any notice. Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Since, also, the trades have not actually been executed; the results may have been under or over compensated for the impact, if any, of certain market factors such as liquidity, slippage and commissions. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any portfolio will, or is likely to achieve profits or losses similar to those shown. All investments and trades carry risks. 1.SMB TRAINING is NOT a Broker Dealer. SMB Training engages in trader education and training. SMB TRAINING offers a number of products and services, both electronic(over the internet through smbtraining.com) and in person. SMB TRAINING also offers web-based, interactive training courses on demand. 2.The seminars given by SMB TRAINING are for EDUCATIONAL PURPOSES ONLY. This information neither is, nor should be construed, as an offer, or a solicitation of an offer, to buy or sell securities. You shall be fully responsible for any investment decision you make, and such investment objectives, risk tolerance, and liquidity needs. 3.This material is being provided to you for EDUCATIONAL PURPOSES ONLY. No information presented constitutes a recommendation by SMB TRAINING or its affiliates to buy, sell or hold any security, financial product or instrument discussed therein or to engage in any specific investment strategy. The content neither is, nor should be construed as, an offer, or a solicitation of an offer, to buy, sell or hold any securities. You are fully responsible for any investment decisions you make. Such decisions should be based solely on your evaluation of your financial circumstances. Such decisions should be based solely on your evaluation of your financial circumstances, investment objectives, risk tolerance, and liquidity needs. 4.SMB Training and SMB Capital Management, LLC are separate but affiliated companies. 5.No relevant positions

3 Unusual Dynamics of the Weekly Options Market Weekly options are heavily traded and have enormous open interest Dwarfing most other option series Large numbers of investors aggressively selling time decay have depressed prices and created unusual distortions These distortions can be profitably traded The dynamics are complex and simple approaches to trading weekly options that worked just one year ago have become obsolete High levels of weekly option activity distort the VIX calculation which never includes weekly options SPX options used for the VIX calculation represent a tiny percentage of the total number of contracts traded on the S&P 500 Option pricing theory dramatically underprices volatility in short time frames. Over the past 100 days, NFLX averaged a unique strike cross every 312 minutes; AAPL averaged a unique cross every 234 minutes. Their respective ATM implied volatilities are 37% and 28%. AAPL Strike (8/23 weekly) Calls Open Int. Puts Open Int. SPX Strike (8/23 Weekly) Calls Open Int. Puts Open Int ,804 1, , ,444 2, , ,340 3, , ,004 3, , ,420 1, , ,373 2, , ,966 1, , ,250 1, , , , , , , , , ,560 8, , ,625 2, , ,347 1, , ,532 2, , , ,371 19, ,915 total 69,206 98,007

4 Short butterflies are margin-friendly, low risk, high return trades that tend to be profitable in many different timeframes. They can generate a profit from rising implied volatility or a modest move of the underlying stock. A typical trade might be composed of: 10 short $100 calls 20 long $110 calls 10 short $120 calls For a net credit. Maximum profit of the trade is equal to the credit Although certain timeframes should be avoided (Thursday with 1 day remaining before expiration or the final weekend), timing is less critical than it is for long butterflies. Wider spacing between the strikes makes the trade more sensitive to movement of the underlying stock but also increases time decay cost. Adjusting strike spacing makes it possible to place profitable trades in almost any timeframe. One of the most profitable times for a short butterfly is in the final hour before expiration when the credit is excessively large and virtually any move of the stock generates a profit.

5 The following data was gathered at the close on Friday 8/16 for options expiring in 7 days. $10 spaced butterfly had a $2 credit and a $10 move in either direction generates a substantial profit even though we are at the beginning of the weekly trading window. $10 Spaced Strikes Midpoint($) Credit 475 / 485 / / 490 / / 495 / / 500 / / 505 / / 510 / / 515 / / 520/ / 525/ $10 move up or down generates a substantial profit. Time decay is $0.097/day. This value will accelerate during the week as the position credit and sensitivity to movement also increases. AAPL $10 spaced short butterfly prices with 7 days remaining before expiration

6 Friday is one of the best days to trade a short butterfly. The distortion is greatest in the final 30 minutes when the credit for a $5 spaced trade approaches $5.00. The table on the left lists average open to close price changes for AAPL during the final 30 minutes and final 15 minutes (25 expirations). The table on the right lists average high-low transitions for the same timeframes. It is clear that $5 spaced short butterflies are profitable even during the final few minutes of trading because credits larger than $4 are common (i.e. a $1 move is profitable). Final 30 Final 15 Final 30 Final 15 Final 30 Final 15 Date minutes minutes AbsValue AbsValue Avg Chng Avg Chng 09/07/ /14/ /21/ /28/ /05/ /12/ /19/ /26/ /02/ /09/ /16/ /30/ /07/ /14/ /21/ /28/ /04/ /11/ /18/ /25/ /01/ /08/ /15/ /22/ /01/ Final 30 min Final 15 min Final 30 Avg Final 15 Date (H-l) (H-l) (H-L) Avg (H-L) 09/07/ /14/ /21/ /28/ /05/ /12/ /19/ /26/ /02/ /09/ /16/ /30/ /07/ /14/ /21/ /28/ /04/ /11/ /18/ /25/ /01/ /08/ /15/ /22/ /01/

7 The following table contains prices for last week s $5 spaced call butterfly on NFLX. Several different timeframes are included. Description Date/Time Days Rem. Stock Price Call Strike Price Credit P&L Mon Morning : Open Trade Tues Morning : Close Trade % Fri Morning : Open Trade Fri Final Close : %

8 Some of the largest profits are generated just before the close on Friday when the credit of the trade is exceptionally large and almost no time remains before expiration. At this point in the expiration cycle, option pricing theory completely fails and the market degenerates into pure gambling. Most retail traders incorrectly believe that the best opportunity for this timeframe involves selling time decay. The following example outlines prices for a NFLX short butterfly placed in the final 90 minutes before the market closed last Friday. A move smaller than $2.00 generated a 63% profit. The large credit ($3.09) would have generated a profit at any closing price above $ or below $ a move of just $1.91. Description Date/Time Days Rem. Stock Price Call Strike Price Credit P&L Fri Afternoon : Open Trade hrs. remaining Fri Final Close : %