Option Strategies: The Best Way to Trade Butterfly Spreads


Welcome back to another edition of Option
Strategy with NavigationTrading.com. In this video, we’re going to discuss Butterfly
spreads. Why do we trade Butterflies? First of all, they are a defined risk trade. We are able to define exactly the amount of
money that we wanna risk on the trade, before we even enter. Second, they are IRA eligible. You can trade a butterfly in an IRA account,
or in a margin account. Third, they are a delta neutral trade. We do not have to have a directional assumption
on the underlying stock, or ETF, before we put the trade on. We like to enter them as Delta Neutral trades. The Butterfly trade is a positive theta trade,
meaning, we, as the options decay, as they get closer to expiration, we collect that
positive theta, which is putting money into our account. Step one, we wanna choose a liquid underlying. Only use trading vehicles on the navigation
trading watch list. If you don’t have a copy of this, go to the
site www.navigationtrading.com, enter your email address and we’ll send you that watch
list for free. You wanna make sure that you’re in a vehicle
that has a lot of volume. You wanna be able to get in and out of that
trade very easily. You want the options to have Tight bid/ask
spreads, so it’s not eating up your profitability for just for making the trade. And then, my preference is to look for opportunities
to trade a index, or an ETF first, and then I look at stocks second. On the watch list, you’ll see they’ll be a
list of stocks that you can trade this strategy with. I personally like to trade ETF’s and indexes
first, and then go to the stocks second. Step two. Choose a vehicle with high implied volatility,
if possible. When we go to the platform, you’ll see that
we are in a very low implied volatility environment right now, so there’s not a lot to choose
from, as far as high implied volatility options. However, if at all possible, you wanna start
with high implied volatility. The way that we measure that is with, looking
at implied volatility rank, and implied volatility percentile. We wanna make these trades, if at all possible,
if the Ivy rank or Ivy percentile is over 50. The next step is to, when you start setting
up your trade, is to choose your window. How many days to expiration do you want your
options to be, to put on the Butterfly trade? 45 days to expiration is optimal. Anywhere between 30 and 60 is a great time
to be putting these trades on. Step four, choose your strikes. A Butterfly is made up of, two short calls
at the money. And then, long calls, should be at or near
the expected move. When we get to the platform I’ll make sure
that, that makes sense. By the way, as a tip, you can set up a Butterfly
spread with all PUTS, or all CALLS. I like to start with CALLS. As long as you’re consistent when you set
them up, that’s all that really matters. Let’s go to the platform and take a look. The vehicle that we’ll look at today, is SPX. Now, as you can see, volatility is very low. What we have on our chart here is the navigation
trading indicator, which shows the Ivy rank in green, and the Ivy percentile in yellow. We really like to see those, one of those
above 50, when we enter this type of trade. There’s really just nothing out there at this
time, at the time of this video, that has that higher implied volatility. We do like to put these trades on all the
time. The trading vehicle that we’ll use as an example
is SPX, which is the S&P 500 index. If you just go to the trade tab here on Think
or Swim … Remember, the days to expiration … We want to be between 30 and 60 days,
to expiration. Stay away from the weekly’s and we wanna stay
really in the monthly options cycles. You see in parenthesis right here, this option
cycle’s 48 days away from expiration. That’s pretty much perfect, right near that
45 day mark that we like to see. When you open your option chain, what you
wanna do is go to the call side, and go to right at the money. The S&P 500 is trading at 2172. We can either choose the 2170 or 2175. It doesn’t really matter. We’re simply gonna right click. I’m gonna use the 2170. Right click. Buy. Butterfly. And then, I’ll populate in the Que, our order. Now, by default, it defaults to the next strike. That’s a very narrow Butterfly meaning, those
strikes are right next to each other. We don’t wanna use those strikes. The long strikes that we wanna use, are, we
wanna base those around the expected move for this time frame, the 48 day time frame. To do that, all you have to do is look over
here in, parenthesis. In this case, it says, 84.3++. We can look at that and round that to 85. Essentially, what we wanna do is … You see
down here, the call on top is a lower strike. We wanna go about 85 points lower, than where
our short strikes are, which are dictated by the negative numbers. There is always gonna be two short calls,
and then a long call on each side of it. The top one will be the lower strike. Let’s count 85 down from 2170. We’ll go 10, 20, 30, 40, 50, 60, 70, 85. That’d be the 2085. We can change this to 2085. And then, we
wanna go 85 points above or higher than 2170. We go 10, 20, 30, 40, 50, 60, 70, 85. That’d be the 2255. We change this to 2255, right there. Those are the strikes that we want. We want our short strikes, the two in the
middle, to be right at the money. And then, we want the call above and the call
below to be, whatever the expected move is. We wanna sit those right around that area. We can right click, analyze this trade. I’ve actually already got on there. I’ll go ahead and delete that one. This is the one that we just set up. This is what your butterfly will look like,
when you look at it from a visual perspective. You can see over here, if you’re looking at
this box, while I hover my mouse, the max risk that we have, on this trade is 3,445
dollars. If the market crashed, and went way down,
that’s the most we could lose. If the market exploded to the upside, that’s
still the most that we can lose. We want this, we want price to stay within
the specific range, and take that off at a percentage of max profit. That’s how we profit from a butterfly. I hope this has been helpful. If you want to learn more strategies about
how we profit from trading these types of spreads, go to www.navigationtrading.com,
or send us an email at navigationtrading.com. To sign up on the site, all you have to do
is provide your email and we’ll send you that free, Implied Volatility Indicator, that I
showed on the charts as well as the Navigation Trading Watch list.

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3 thoughts on “Option Strategies: The Best Way to Trade Butterfly Spreads

  1. Good start to this video.  Ending when looking at platform could have been explained in more detail – risk, reward, profit zone, how / when to adjust or close…

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