How to Manage Butterflies w/ Option Trading? #HungryForReturns 6

September 18th, 2018

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Hey, this is Sasha welcome to another episode of "Hungry for Returns."

In this show, what I want to do is answer your trading and investing questions whether it comes from options or just stock trading based on my own experience and understanding.

Today's question is about managing or more really about taking profits of a butterfly.

"Hi Sasha GM of a thousand questions here. My question for today is regarding how to manage butterflies because I am still working I like to write sell orders on the positions I have. I don't need to hit home runs in the stock market. I am content with making a small 2% per month, if possible. So, my question is regarding butterflies -- if I write a butterfly for a cost of $1.00 per contract and I want to write a good Tilt canceled order to exit the position to lock in my profits, at what price point should I write my exit order? Is a 50 cent profit too low? Is a two or three dollar profit too high? That's my question for today thanks, Sasha."

This is going to vary depending on the spread that you're putting on the stock that you're trading, the volatility conditions that we are in.

There's a lot of variables that go about with taking profits into strengths.

As far as making 2% a month, I think that's fair, and with experience, that shouldn't be a problem trading butterflies if you're managing them accordingly.

I want to give you a little bit of a guideline when it comes to butterflies or really option trading in general of when to take your profits.

The first thing is it's going to depend on your setup and how long you're in the trade.

If you're in a shorter term duration, let's say 20 days or less, then you'll be in the trade a lot less. You might take it a little quicker.

If you're in the trade a little longer, then you'll be in the duration a little bit longer, and you might make a little bit less.

Typically, what I would say if you're trying to stretch whether you're doing yoga. You're trying to stretch and continue to grow.

The same thing here with options trading is you're trying to stretch your profitability potential.

Let's say I have a butterfly set up like this. If you want to make it a little more balanced, you could go ahead and increase one of the sides on the wings and make it a little more balanced.

When you do this, you're starting to look at -- how far or what do I want it to do and when do I start taking my profits?

That's, I guess, the big question.

When you're looking at the profitability of this, this one is if we're looking at the duration about 57 days out, what you want to do is start looking at when that curve starts to get too far extended to the wings or to the edges or when you come into maybe too much profitability.

It's almost at the point when you're getting a little more greedy is when you should be taking those things off?

Initially, when you're just putting on and trading options, you're going to probably take your butterflies off maybe just a few days into them.

Let's say you put on a trade for $3,000. You might take it off for $100/$150 profit, and that's a nice sweet spot because you're stretching your muscles.

If your first try and bend down and touch your toes and you can't do it, and you're this far away, you got to get more practice. You got to do it more often.

At first, it might be $50 hundred dollars but a little sweet spot. It could be a quarter of a percent. It's not a lot later on you start stretching a little bit more. That white line will start getting them into more of your favor. You might see some positions, let's say three months of doing these -- maybe six months of doing this, you might have one or two in there that you made $370, from a max profit of about 2900 or so.

Then again, if you do that a couple of times later, still you start stretching things. A few more days might go by or a few more days might go by into the next segments.

Let's say, two to three to six months of $100 profit. Three to six months of $300 benefit. Then, if that's good then, try and pull it a little further to maybe $500/$600.

You're continually stretching that a little bit. I would say, once you're getting into these butterflies where you know you're, say a little bit 20 percent profitability of your max just getting in twenty percent of what you're total maximum, that you could do that's starting to start to push it.

Now, it depends on the type of butterfly that you do though of course so let's say this butterfly just hung out here for weeks and weeks and weeks, I'm still looking for a price increase. I'm positioning this butterfly, let's say a little bit further out, and I'm looking for that price movement, and it's just hanging out, I'm in my sweet spot right. I feel comfortable with that because that's the type of butterfly setup.

I might get lucky here and there, where hey this thing is expiring and getting close to expiration, where I'm up already $600, and it's starting actually to move in my favor and then I'm getting into $1,800 which let's just say it's about 60/70 percent of my maximum profitability. You're starting to get into greed territory or hey this is a lucky situation and worked out in your favor.

Those may happen from time to time, but I wouldn't say it's as standard, but again it just depends on how you set up your trade-in positions. I'd say by then definitely start taking your profits off even if you were back in the lower price or close to your wing. You had three or four contracts you might take one or two of those off.

It's important to start stretching slowly. As you start getting better at stretching, you'll be able to reach further and touch your toes further.

The same thing here, as you get a little bit better, you'll try and go a little further from a hundred dollar profit. You might go two to three hundred dollar profit. Or from a quarter of a percent, you might go to half a percent and so on.

You slowly start increasing that time and time again. You'll be able to see that because you're doing these butterflies, usually on the same vehicles or the same stocks or ETFs or indexes time and time again.

The first six months, you might only make let's say a hundred dollars from an average. Sometimes, you might lose fifty or a hundred dollars. Sometimes, you might make one hundred and fifty dollars, but that's your range.

Then you try and increase that to 150 maybe 200. Once you get into about half of that profitability, by then you know half of your max, you'll start to gain an understanding of what's my potential how far can I stretch this thing.

Eventually, it's just the risk starts to outweigh the reward.

I hope that makes sense. It's not so much about the amount, as far as the contract size like 50 cents to a dollar that you're taking things off. It's more of your potential or profitability, and you're looking at the days that you're in the trade too.

If you're in a sixty-day trade, you might take it off in 30 days maybe 20 days. You'll be in the trade a lot longer on longer-term duration trades because the Theta decay is a little slower. On shorter-term duration trades, you'll be in them a little bit less but you have a pricing problem because if price wiggles around, there's a pricing issue but at least volatility is not as big of a deal because the Theta will make up for that Vega problem.

Whereas longer-term duration trades, you have a bigger Vega and a Vega problem but not as much of a pricing problem.

Anyways, I hope that makes a little more sense and gives you a little perspective to stretch a bit further on your trades.

Author: Jorge Diaz

I'm Sasha, an educational entrepreneur and a stock trader. In addition to running my own online businesses, I also enjoy trading stocks and helping the individual investor understand the stock market. Let me share with you some techniques & concepts that I used over the last 10+ years to give you that edge in the market. Learn More

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