Butterfly spread. Follow-up question


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.


14 Responses to Butterfly spread. Follow-up question

  1. Don 10/30/2009 at 12:30 PM #

    Hi Mark Ii read your posts about butterflys, condors and IC with great interest, you had said the following “If you were to buy a condor (see tomorrow’s post) instead of a butterfly, you could move the short strike more than 10 points – and that could easily be worthwhile – at the right price.

    WIth a 550/560 620/630 RUT spread the movement has been towards the short 560 recently. YOu are correct that the 540/55/560 Butterfly only gathers a 10 pt addition and as you said over a 600 point basis that can easily be maintained. AS an example would you illustrate how you would use the condor to gather an additonal 50 points to a 500/510?

  2. Mark Wolfinger 10/30/2009 at 12:43 PM #

    Okay, but 50 points is too costly – in my opinion. Especially to stay in front-month options. If the spread were December, that would be different.
    At the current price, I closed all my 560 put spreads. I was able to sell long puts against them, making the close painless.
    But if you want to roll for 50 points:
    Buy this condor:
    Buy 550/560 put spread
    Sell 500/510 put spread
    It’s just a roll down. But if you do both spreads at the same time, you would be buying the 500/510; 550/560 Put condor. This is similar to buying the butterfly – with a separation between the strike prices.

  3. Don 10/30/2009 at 4:48 PM #

    Right, thanks, of course that makes total sense, especially when I see it so clearly stated. The judgment would have to be the cost/reward and how many points to move it. To fit each individual comfort zone.
    I didn’t understand part of what you did, you closed the 560 Put spreads, got that-then you sell long puts against it- I know that you typically do not recommend selling naked puts unless picking up stock is a part of your investment plan. Is there something else that you are doing when you do this?
    FWIW, I think that this is the most complete and accurate options discussion site on the web, I read the comments becuase I know about them, but I am sure that many people, especially new people do not- they are LOADED with information, many of them could be posts themselves. I also think that this site (if you desire larger readership) would benefit from marketing and associations with other sites- I read seeking alpha for instance and whether you like or dislike that site it is focused on investors and writers and your unique perspective would certainly stand out there- I am sure that there are others that would also generate more readership for you- I have seen the site grow and it truly is excellent-

  4. Marty 10/30/2009 at 6:51 PM #

    Thanks Mark,
    I’m a little confused. You said, “A butterfly doesn’t have a point of max pain…There is only a small profit zone.”
    I think we may be talking about opposite sides of this trade. Let’s say I went:
    Long a 100 call
    Long a 100 put
    Short a 97 put
    Short a 103 call
    And the underlying is right around 100
    The max pain at expiration should be $300 minus the difference in premium paid and premium collected, right?
    Thanks again,

  5. Mark Wolfinger 10/30/2009 at 7:23 PM #

    1) Sometimes is just too near expiration to roll the short spread in the same month, but that’s up to the individual trader.
    2)What naked puts? I assume you are talking about the trades I made. I bought the 550/560 put spreads and sold some of the puts that I already owned. I owned those extra puts becasue I bought insurance before I needed it.
    When I said I sold ‘long puts’ – the term ‘long’ means I own them. You have been trading long enough to know the diffrence between long and short. I sold puts I owned, not naked puts.
    Yes, I very much want a larger reader base. I submitted to Seeking Alpha one time, but never heard from them. Being ignored is not something I appreciate. I may try again.
    I do post on minyanville.com.
    One reason many do not see the comments is that they subscribe through the RSS feed.
    Thanks for the kind words. I try very hard to make this site worth visiting. The work hours are getting longer and I must find a way to earn some money from blogging. I’m considering a premium membership site – but I must do that while maintaining the quality of Options for Rookies.

  6. Mark Wolfinger 10/30/2009 at 7:36 PM #

    I have never seen the term ‘Max Pain’ used to describe a sum of money.
    The term usually refers to a price, or range, at which the investor loses the maximum.
    Using that definition, with your position, Max Pain occurs at 100.
    But earlier, I thought we were talking about owning a butterfly position. With a 97/100/103 butterfly, every price below 97.01 and above 102.99 is the area of Max Pain.
    Yes, we are on opposite sides of the trade. Very few retail traders sell butterflies. Nearly everyone buys them. Thus, I assumed when speaking of butterflys, you were referring to being LONG the butterfly.
    Instead of owning a butterfly, many prefer to trade the iron butterfly. But you traded it backwards. Most investors sell the call spread and sell the put spread. You bought both.
    So YES, the price of 100 is the point of MAX Pain.
    About your numbers: You received no credit. You bought the call spread. You bought the put spread. You paid a debit. Your loss is not $300, it’s the premium you paid for the iron butterfly.

  7. Marty 10/30/2009 at 8:22 PM #

    Yes, I see what you mean. Not a loss, just the price to open the spread. Sorry about the confusion on terminology. I wish there was a clearer way to describe which side of these winged trades a person is referring to than saying buy or sell. So now that we agree on the side we’re talking about, since you say that buying the fly can be a decent play and that most retail investors wouldn’t sell one, do you think it is inherently a bad idea to sell for any particular reason?
    My thought is that if someone could predict when a period of higher volatility was about to begin but didn’t know the direction, selling an iron butterfly would be a better move than purchasing a straddle or strangle.

  8. Mark Wolfinger 10/30/2009 at 9:05 PM #

    There is a good way to describe the situation. If you don’t want to talk about by or sell, then you can use the words ‘long’ and ‘short.
    If you talk about being long a butterfly or iron condor, everyone understands that you bought it or are planning to buy it.
    When it comes to credit spreads, all that’s needed is keeping the language simple. A spread is defined by the more expensive options. Consider the 80/90 call spread.
    You BUY the spread when you buy the 80 call and sell the 90 call. There is no need to say yu are buying the bull call spread. “Bull’ and ‘bear’ are unnecessary terms.
    Same with puts. When you buy the spread, the buy the more expensive put.
    Thus, an iron condor is constructed by selling the call and put spreads. If you are uncomfortable using the terminology I prefer – buying the iron condor – then just say you own an IC and we all know that you sold the call and put spreads.
    There is no reason not to sell butterflys. It’s not a trade made by inexperienced traders. That’s ust the way it is. Invesors like to pay a small price and turn it into a big win. It’s a mindset.
    I could not disagree with your last statement more. Butterflys are not affected very much by an IV increase, but straddles and strangles can double overnight if IV surges enough. If you don’t believe it, try it with a pricing model.
    That’s why these calculators exist. They allow you to do your own work and then you will remember the results.
    By the way, when you say ‘sell an iron butterfly,’ I have no idea what that means to you. To me it’s equivalent to selling the butterfly – and I assume that’s what you meant.

  9. Dave 10/31/2009 at 9:26 PM #

    If it’s any consolation in regards to reader base, blog work hours, and earning money, I’m new and I’m buying your book because of your blogging.

  10. Mark Wolfinger 11/01/2009 at 9:04 AM #

    Thanks Dave.

  11. Marty 11/01/2009 at 12:47 PM #

    “Butterflys are not affected very much by an IV increase, but straddles and strangles can double overnight if IV surges enough. If you don’t believe it, try it with a pricing model.”
    I do believe it…for a strong downward move in prices, but what about a sudden breakout to the upside? Since IV usually doesn’t respond equally to downward versus upward moves in underlying, I would think selling a butterfly would be the better alternative for a true market neutral position. To profit consistently from purchasing straddles it seems that the trader would need to predict not only when the sudden increase in real volatility was going to start, but also have a reasonably good feeling that prices were headed lower once the breakout begins.
    To answer your last question, my understanding is that the iron in iron butterfly denotes using calls and puts together, rather than only calls or only puts in the butterfly. They’re equivalent other than initial debit or credit, so in my mind selling is selling no matter if the spread is iron or “normal”.
    FWIW though, I disagree with the long/short, buying/selling nomenclature for these types of spreads because it doesn’t fit. A different type of description is needed all together such as “opening” an “inner short condor”.
    If long/short has to be used though, my opinion is that a winged position where the inner options are short should be called “selling” or “shorting” the spread, and inner long options for “buying” or “going long”. After all, we would call the first scenario “selling premium”, so why confuse the matter by referring to the same side of the trade a long position? I’ve heard arguments to the contrary, but they are less than convincing to me.

  12. Mark Wolfinger 11/01/2009 at 2:28 PM #

    Hi Marty,
    1) The true market neutral position begins with zero vega (as well as the other Greeks). Most of us don’t want to trade that way.
    We choose an iron condor, or a butterfly, or a covered call etc as our basic strategy, and live with the Greeks that come with it. Konowing the Greeks was part of the decision that leads us to our favorite strategy.
    I like market neutral strategies, but for the average individual investor, being markt neutral is unusual. Most prefer to have a directional bias, and the results of that bias are going to outweigh the fact that a position has vega or theta risk.
    Trading a stradle is considered to be a market neutral strategy by most people. Not me. It may be near delta neutral to begin, but it’s a very bad choice for most investors – regardless of whether one buys or sells the straddle.
    I do buy strangles on occasion – but only as insurance. Never as a play designed to earn a profit.
    2) If you like the idea of selling a butterfly spread, I am not making any effort to dissuade you. Speaking from the perspecitive of the individual investor – the readers of the blog – selling a butterfly for a low premium is just something that is not popular.
    There are so many other trading stratgies that I decided to ignore butterflys in general – because I consider a butterfly and condor to be so similar, that there is no need to cover each in depth.
    3) I have never said, and I trust that I never will, that buying straddles is a good idea. I consider it to be a VERY high risk stratgy with a very negative expectation – most of the time. The occasional big payoff is what keeps people returning to play again. If you are agruing against the idea of buying straddles, you can’t argue with me. I totally agree.
    I would not disapprove of owning a straddle (other than as insurance) for one specific reason – and even then I would find another play. That occurs when the trader wants to bet on a big jump in IV.
    If IV jums enough, it doesn’t matter where the stock is headed. Just sell the straddle and take the profit.
    4)Yes, the ‘iron’ designation refers to calls and puts together. The reason for that is that the two spreads are sold. Sell call spred. Sell put spread. That differs from the non-iron version in which one spread is bought and another sold – and those require all calls or all puts.
    I cannot help how it appears ‘in your mind.’ And I am not saying that you are wrong. But it’s a pointless argument. There is no one to declare a winner. There is no judge and no jury. Use whatever terminolgy suits you. But be very careful that you are understood. You do not want to give a verbal order to a broker only to discover that he did not know what you were trying to trade. They will not break the trade just because you used a word (buy or sell) that disagrees with how they use the word when referring to a specific spread.
    5) The fact that arguments you heard are less than convincing to you just points out that care is needed. You must be able to communicate what you mean by buy or sell. That’s all that matters. It’s far too late for the options world to agree on definitions At least it’s too late in my opinion.
    But I am stil not sure if we are in disagreement when you say ‘selling is selling,’ you appear to contradict yourself – or at least that’s how it seems to me.
    When I buy a condor, I buy the wings. When I buy an iron condor, I buy the wings. We agree that selling the middle strikes is selling the position, and thus, you appear to agree with the idea that when you buy the wings of either position, you are ‘buying’ the spread.
    But, when I buy a condor, I pay cash. When I buy an iron condor, I collect cash. You don’t seem to agree that these are both ‘buying.’

  13. Marty 11/01/2009 at 4:00 PM #

    Thanks again for the help on this one. I think I’m in agreement with you on most of this issue. As far as the long/short thing goes, from now on I’ll try to phrase my questions as
    “…opening (or closing) an iron condor with Long 34 Put, Short 35 Put, Short 39 Call, Long 40 Call…”
    It’s a little more to type, but eliminates any confusion about what side of the trade I’m on.

  14. Mark Wolfinger 11/01/2009 at 4:12 PM #

    Eliminating confusion is the goal.
    I write ” 34/35; 39/40C IC” and so far have not gotten into communication problems. Your method eliminates all possibilities of having a problem.