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Butterfly Spreads- A conservative trading plan |
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The stock market always rides a wave that is not predictable and various factors impact the volatility. Spreads are strategies that manage your investments and are suggested by various experts as the smartest way to invest in options. |
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| Author: Sumant |
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• The spreads that should be considered are:
• Calendars
• Double calendars
• Condors
• Double diagonals
• Butterfly spreads
Entry Criteria:
A butterfly spread has options that have the same expiration date. A long butterfly spread will include 3 call (or puts) strikes, buy one at low strike, sell two at the middle strike, and buy one at the high strike. A long butterfly is a combination of a bull and bear spread. For example, a 90, 95, 100 call butterfly will involve buying one 90 call option, selling two 95 call options and buying one 100 call option.
The butterfly spread limits profits and risks. The strategy should be placed when volatility is relatively low.
Pick stocks (or ETF's) after a detailed research
The IV should be in the lower 30% of the underlyings two year range.
Consider stocks that moving laterally and do not show a lot of movement. Some stocks may remain stable over long periods and are a good choice.
Special events like earning months of a stock should be avoided. High volatility occurs during the months when results are due and announced.
The price movement patterns of a stock should be predictible since butterfly spreads benefit from stocks remaining in a certain range; start-ups and bio-tech industries must be off the list. Index products are preferred.
Timing:
A post-earning month is an ideal time as stock volatility will be low
Intiate the butterfly spread around 4 weeks before expiration.
Profit Goal:
30% (after commissions)
Maximum Loss:
25% to 30%. Once your position is down between 25 to%, close the position
Adjustments:
The adjustments points should be set at the break-even (BE) points of the spread for the first two week period
Once a position is up 20%, set stop orders so that a return of 10 - 15% is guaranteed.
Try to get a fill at the mid-price between bid-ask. Try not to digress from mid-prices - if at all you do, try to give up not more than $0.05 to $0.10 from mid prices since execution is crucial.
Get out of the trade two weeks before expiration. It becomes more difficult to manage a position as it gets closer to expiration.
When stock starts to become volatile showing wider than normal daily movements, close your position as some events cannot be easily managed closer to expiration.
Shop around for brokers that offer low commissions (less than $1.50 / contract & no ticket fee)
About Author
OPTIONWIN aims to simplify the analysis of options on stocks, indices and ETF's. It is based on revolutionary technology built by experts with over 25 years of cumulative experience in dealing with equity & derivative systems, and aims to bring sophisticated computation within reach of retail and small institutional investors.
Article Source:
http://www.1888articles.com
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