2013/08/20 Introduction to the Weekly Short Butterfly Jeff Augen 2013/08/20
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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. 465 1,804 1,929 1620 18 2,148 470 2,444 2,129 1625 10 17,109 475 2,340 3,606 1630 13 3,638 480 3,004 3,284 1635 7 1,344 485 2,420 1,907 1640 31 7,274 490 2,373 2,165 1645 29 3,136 495 3,966 1,809 1650 88 14,279 500 6,250 1,811 1655 92 5,828 505 5,981 391 1660 700 4,591 510 4,146 349 1665 1,316 820 515 6,464 180 1670 753 3,044 520 2,553 46 1675 5,560 8,589 525 1,429 72 1680 2,625 2,346 530 1,968 12 1685 1,347 1,152 535 1,082 64 1690 4,532 2,784 540 1,147 81 1695 1,971 833 49,371 19,835 19092 78,915 total 69,206 98,007
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.
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 / 495-0.70 480 / 490 / 500-1.45 485 / 495 / 505-1.60 490 / 500 / 510-1.90 495 / 505 / 515-2.00 500 / 510 / 520-1.94 505 / 515 / 525-1.40 510 / 520/ 530-1.16 515 / 525/ 535-0.78 $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. Stock @ 503.10
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 09/07/2012 0.14 0.16 0.14 0.16 2.01 1.87 09/14/2012-1.55-0.41 1.55 0.41 09/21/2012-1.43 0.02 1.43 0.02 09/28/2012-3.15-2.70 3.15 2.70 10/05/2012-1.43-1.08 1.43 1.08 10/12/2012-0.31-0.15 0.31 0.15 10/19/2012-4.26-3.34 4.26 3.34 10/26/2012-5.25-4.58 5.25 4.58 11/02/2012-4.71-2.10 4.71 2.10 11/09/2012 1.49-0.89 1.49 0.89 11/16/2012 3.69 1.98 3.69 1.98 11/30/2012 1.06 1.37 1.06 1.37 12/07/2012-1.04 1.50 1.04 1.50 12/14/2012 1.63 2.98 1.63 2.98 12/21/2012 4.31 3.41 4.31 3.41 12/28/2012-1.82-3.42 1.82 3.42 01/04/2013-2.34-3.53 2.34 3.53 01/11/2013-0.46-0.65 0.46 0.65 01/18/2013 1.40 0.69 1.40 0.69 01/25/2013-4.09-6.43 4.09 6.43 02/01/2013-0.14 1.48 0.14 1.48 02/08/2013-2.79-1.63 2.79 1.63 02/15/2013-0.27-0.15 0.27 0.15 02/22/2013 0.70 0.38 0.70 0.38 03/01/2013-0.79-1.64 0.79 1.64 Final 30 min Final 15 min Final 30 Avg Final 15 Date (H-l) (H-l) (H-L) Avg (H-L) 09/07/2012 0.85 0.80 3.87 3.27 09/14/2012 3.12 2.10 09/21/2012 2.83 2.05 09/28/2012 4.08 2.97 10/05/2012 3.24 2.64 10/12/2012 1.69 1.69 10/19/2012 4.88 4.05 10/26/2012 6.42 6.42 11/02/2012 7.02 4.51 11/09/2012 4.05 3.85 11/16/2012 5.31 3.66 11/30/2012 2.22 1.92 12/07/2012 4.70 4.36 12/14/2012 4.70 4.58 12/21/2012 4.73 3.90 12/28/2012 6.14 5.32 01/04/2013 4.64 4.33 01/11/2013 1.68 1.34 01/18/2013 1.60 0.93 01/25/2013 10.92 10.92 02/01/2013 3.17 2.66 02/08/2013 3.53 2.45 02/15/2013 1.00 0.98 02/22/2013 1.88 1.34 03/01/2013 2.30 2.10
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 2013-08-12 9:30 4.27 250.42 245 7.29 Open Trade 250 4.26 255 2.20-970 Tues Morning 2013-08-13 9:30 3.27 258.84 245 14.08 Close Trade 250 9.63 255 5.88-700 28% Fri Morning 2013-08-16 9:42 0.26 251.20 245 6.21 Open Trade 250 1.71 255 0.07-2860 Fri Final Close 2013-08-16 16:00 0.00 258.87 245 13.87 250 8.87 255 3.87 0 100%
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 $256.91 or below $253.09 a move of just $1.91. Description Date/Time Days Rem. Stock Price Call Strike Price Credit P&L Fri Afternoon 2013-08-16 14:38 0.06 256.90 250 6.90 Open Trade 255 1.93 1.5 hrs. remaining 260 0.05-3090 Fri Final Close 2013-08-16 16:00 0.00 258.87 250 8.87 255 3.87 260 0.00-1130 63%