Since your personal preference is to be a premium seller, I think I can guess
what your answer will be…but I'd like to hear it anyway.
You mention above that there is a "VERY low probability of collecting
anything resembling the maximum reward" on a butterfly. That makes sense, but
would you say that the probability of good returns is low enough on the
sell-side to make "buying" butterflies a decent play (at least relative to paying a debit for ICs, with which I would not be comfortable)?
My question is: Assuming the trader could guess with a decent rate of success
when periods of higher actual volatility would occur – I realize that's a big if
– is the deck fundamentally stacked against the "buyer" of a butterfly? In the
strategy I'm imagining, the trader would need to 1) identify when a period of
strong underlying movement was about to begin 2) determine when the period of
movement was exhausted (not holding until expiration…so when to take full or
partial profits) and 3) decide when to pull the plug if the underlying looks
like it's going to settle in the zone of maximum pain.
What other factors am I missing? The strategy would also benefit from a
rising IV environment, correct? And just to reassure you, this all purely
speculative and academic at this point…I don't have money on the line.
Yes, buying butterflys is a decent play. If you pay 50 cents and are willing
to sell at a bit over $1.00 – then it's a decent play. If planning to hold
through expiration, then it's not so good (my opinion).
The problem is that expiration week arrives, and you can only get about $1.50
for your near-ATM fly. You want to hold out for much more – perhaps $7 (10-point
That's the problem. With so little time remaining, investors hold and the fly
often becomes worthless.
That does not appear to be your plan. So yes, low cost butterfly spreads are
Rising IV – yes it helps, but barely. The closer to the money spread (the one you own)
would increase by a little more than the farther OTM spread (the one you sold),
for a small net gain.
Theta is more important than vega in this trade.
I don't think you are missing much. The butterfly is a bet on market
direction (if you buy OTM) or stability (if you buy ATM – but these always cost
I don't trade these, but my advice is to not be greedy. These are trading
vehicles more than investments.
One more point. A butterfly doesn't have a point of max pain. Almost the entire universe of possible prices for the underlying results in max pain for the butterfly. There is only a small profit zone.