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Butterfly Trading Strategies part 1 of 3, 2/4/12

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  1. Butterfly Trading Strategiespart 1 of 3, 2/4/12 John Locke Locke in Your Success, LLC. Know what you want, make it happen! I teach traders how to improve their trading and become more profitable! www.lockeinyoursuccess.com © 2012 Locke in Your Success, LLC.

  2. Disclaimer • Any information contained in this presentation is for educational purposes ONLY. Neither Locke In Your Success, LLC, John Locke nor it’s subsidiaries nor any of their respective officers, employees, representatives, agents or independent contractors are, in such capacities, licensed financial advisors, registered investment advisors or registered broker dealers. Neither do they provide investment nor financial advice nor make investment recommendations, nor are they in the business of transacting trades. Nothing in this communication constitutes a solicitation, recommendation, promotion, endorsement or offer (buy or sell) by Locke In Your Success, LLC, or others described above, of any particular security, transaction or investment. • * The risk of loss in trading securities, options, futures and forex can be substantial. Customers must consider all relevant risk factors, including their own personal financial situation, before trading. Options involve risk and are not suitable for all investors. See the Options Disclosure Document: Characteristics and Risks of Standardized Options, available at www.lockeinyoursuccess.com © 2012 Locke in Your Success, LLC.

  3. The “High Probability Iron Condor” Risk $9000 to make $900….YUCK! © 2008 Locke in Your Success, LLC.

  4. The “Low Probability Iron Condor” Risk $7300 to make $2700……Better © 2008 Locke in Your Success, LLC.

  5. The “Very Low Prob Condor” or the “Butterfly” Risk $1500 to make $3600…. Yes!! © 2008 Locke in Your Success, LLC.

  6. Butterfly Challenge • Risk reward is great  • Range stinks  • How do I take a butterfly which has a great risk/reward ratio and give it the same range as the “high probability iron condor”? © 2012 Locke in Your Success, LLC.

  7. The Answer • Method 3 Butterfly late 2007 (M3) • Method 9 Butterfly early 2008 (Bearish Butterfly) © 2012 Locke in Your Success, LLC.

  8. Since then…. • The M3 and Bearish Butterfly have been traded through some of the most volatile markets in history! • 08 crash, 10 flash crash, 11 crash in Aug • Record rallies in 09, 10 • Made improvements along the way © 2012 Locke in Your Success, LLC.

  9. M3 Trade System • The M3 is a trade that has evolved into a system that I now use as a learning tool. • The M3 allows traders to learn “proper” position analysis, position control and decision making processes while trading a live position, experiencing live execution and maintaining relative safety in the market place. • The M3 is designed to minimize risk or “not lose money”. • It is not designed to create large monthly profits. © 2012 Locke in Your Success, LLC.

  10. M3 Trade System • The M3 can be used as a stand alone trade system. • As a stand alone system the M3 has historically produced an average of around 3-5% per month for most of my students. However past performance can not predict future results. • I still trade the M3! © 2012 Locke in Your Success, LLC.

  11. Advantages of the M3 • No searching for stocks. • No need to pick direction. • Can be entered regardless of market conditions • Most adjustments are not urgent • No need to sit in front of the computer all day • Can be in the market, making money from anywhere in the world, in any time zone, even while on vacation. © 2012 Locke in Your Success, LLC.

  12. I can trade while I’m skiing. © 2012 Locke in Your Success, LLC.

  13. I can trade while I’m at the lake. © 2012 Locke in Your Success, LLC.

  14. I can trade when I’m jumping off buildings in Las Vegas. © 2012 Locke in Your Success, LLC.

  15. I typically check this trade once a day • Most of the time I don’t need to do anything. • The times that I do need to do something, I can usually put it off. • Only in rare cases would I NEED to jump in and do something right away. © 2012 Locke in Your Success, LLC.

  16. M3 does not have “hard” guidelines • Trading from a rule sheet does not teach you to become a great trader. • Knowing the concepts of trading as well as how, why and when to apply those concepts is teaches you to trade. • The M3 uses concepts instead of a rule sheet. © 2012 Locke in Your Success, LLC.

  17. Underlying Concept of M3 • Maintain positive Theta, relatively flat Delta, low Gamma and negative Vega. • More important than the current Greeks are the Greek trends (what going to happen to the Greeks at any given price point on the analyze graph, as time goes by) • Use a stock, or stock substitute, with a bearishly positioned options spread (butterfly) position. • Assess risk daily by analyzing, the Greeks and the Greek Trends and then adjust the position if needed. © 2012 Locke in Your Success, LLC.

  18. Typical Entry Position © 2012 Locke in Your Success, LLC.

  19. Typical Entry Position © 2012 Locke in Your Success, LLC.

  20. Object • The object of the game is to keep the proper balance between the butterfly and the stock or stock substitute while maintaining positive Theta, neutral Delta, low gamma and negative Vega but most important I want to maintain favorable Greek Trends in my area of concern © 2012 Locke in Your Success, LLC.

  21. Preferred Positioning © 2012 Locke in Your Success, LLC.

  22. Underlying for examples is RUT • RUT put butterflies with 50 point wings • Butterflies are hedged with either RUT calls, IWM calls or IWM stock. We will use RUT calls. • The ratio of the butterflies to stock will vary with butterfly pricing (or implied volatility) • M3 can be used with other indices and some stocks but wing width and ratios may vary © 2012 Locke in Your Success, LLC.

  23. Entry Guidelines Entry: Approximately 56 DTE Butterfly Positioning: Short strikes 20 – 30 points below underlying Longs: Purchase sufficient number of deep ITM long options (or stock) so the opening position is either flat Delta or leaning slightly in the direction of your market opinion © 2012 Locke in Your Success, LLC.

  24. Planned Capital • “Planned Capital” IS a fixed number that we use to base our risk management numbers off of and is a reasonable representation of the maximum amount of capital we are likely to have in the trade during an average month. • Trades with varying capital cannot be properly managed with profits and losses based off of a percentage of “whatever is in the trade” because these trades almost always have substantially more money in them when they win lose than they do when they win. • “Planned Capital” IS NOT the maximum amount allowed in the trade. • In low volatility months with large price moves or if trading into expiration, your capital may substantially exceed the planned amount. © 2012 Locke in Your Success, LLC.

  25. Risk Management • Planned Capital: $5,000 - $ 8750 per IWM call depending on butterfly/call ratio which will vary with market conditions and underlying/s you are using • Target Profit: +10% of planned capital • Max Loss: -10% of planned capital © 2012 Locke in Your Success, LLC.

  26. Adjustments • We are going to use a combination of techniques including verticals, varying butterfly to call ratios and moving the butterflies to maintain desirable Greeks and Greek trends while maintaining a reasonable amount of capital in the trade. © 2012 Locke in Your Success, LLC.

  27. Desired Greeks • Desired Greeks will vary depending on position size, the trend of the Greek we are looking at and the direction of movement we are concerned about. • Greek management is based off of position size. • Position size is determined from how many IWM calls the position has. (1 RUT call = 10 IWM calls) • For today position size will be 1 RUT call (10 IWM calls) © 2012 Locke in Your Success, LLC.

  28. “In General”The desired Greeks for the position size of 1 RUT call are… • Delta: Ideally +/- 50 • Acceptable +50 to (-)100 • Delta may exceed this range with favorable Gamma trend © 2012 Locke in Your Success, LLC.

  29. In General • Gamma: (+) is good / (-) is bad • Unfortunately negative Gamma is a byproduct of Theta (unless we are naked options which we are not) • The total Gamma number, however, is not as important as the trend of Gamma. As long as Delta is under control and Gamma is trending positive in the direction of concern at a favorable rate, there is no problem. Gamma trend can be observed with the analyze graph. © 2012 Locke in Your Success, LLC.

  30. Theta and Vega • Theta: Positive!!! More is better!!! • BUT, more Theta is better ONLY if Gamma and Gamma trend are under control. There are times it is favorable to reduce Theta to mitigate Gamma risk. • Vega: This trade should maintain negative Vega…How much? • When IV is high, especially under conditions when the price is likely to stabilize, then we want more negative Vega • When IV is low especially when the price is very over bought, we want “less negative” Vega © 2012 Locke in Your Success, LLC.