There this site Vix and more which i came across as being a good guide to options and all things volatility of the market.

This week there is an article on how one can take advantage of volatility as a hedging function or as an opportunistic bet:

Fortunately, there are a number of VIX derivatives that allow traders to take positions on the VIX without owning the underlying. In no particular order, they are:

1. VIX options – these include standard options as well as VIX binary options

2. VIX futures – standard VIX futures contracts have a contract size of 1000 times the VIX; the recently added mini-VIX futures have a contract size of 100 times the VIX
3. VIX ETNs – currently consists of two exchange traded notes: the iPath S&P 500 VIX Short-Term Futures ETN (VXX) and the iPath S&P 500 VIX Mid-Term Futures ETN (VXZ). The former targets one month VIX futures and the latter targets five month VIX futures.

In addition to VIX products, one can always trade options on the SPX (or SPY). A long VIX position is very similar to a long SPX straddle (or strangle); a short VIX position is very similar to a short SPX straddle (or strangle.)

[Read the full article at Vix and More >>]

Citigroup seems to be a good option for him since its cheap at USD 5 and writing 600 call contracts requires him to have 3k USD.

What does a double top in the VIX signify? I will say it could go either way. A triple top in VIX seems rare, but the MACD reading seem to show that upside to this is possible short term wise. A move lower could prove to be a catalyst for a sideways market or the freaking bottom everyone is trying to call here.

Banks have assets and liabilities. If the bank borrows money from individuals, the liabilities are called “deposits”. Alternatively, the bank can borrow money from other banks, in the interbank market, or from the Federal Reserve. All of those borrowings are unsecured, and more creditworthy banks pay lower interest rates than less creditworthy banks in the interbank market. Banks can also issue bonds, if they want, which are also unsecured, and which can have much longer tenors – sometimes they’re even perpetual.

Recently, the market has been having a lot of concerns about the creditworthiness of banks in general. Interbank borrowing costs have gone up, while the prices of banks’ bonds have gone down. In such a situation, one way of bringing down borrowing costs is to borrow against collateral – secure the debt, rather than issuing unsecured debt.

Now historically, banks haven’t done this. If they have a pool of assets they want to secure, they’ll securitize it – basically, sell the assets outright to an off-balance-sheet special purpose entity for which they have no legal responsibility. In return for the assets they get cash on the barrelhead – they’re not borrowing money they’ll have to pay back in future.

But the securitization market, too, is broken right now. Investors have very little trust in the banks’ assets, which are things like mortgage loans. If the banks try to sell the loans outright, they won’t get much money for them.

Enter covered bonds.

With a covered bond, the bank doesn’t sell its assets (in this case, its mortgages); rather, it continues to own them, and it borrows money against them. If the bank ends up going bust, the lender can take possession of the underlying assets – the mortgages. But until then, the lender doesn’t own the mortgages, it just has a debt obligation of a bank.

There are two good things about covered bonds. The first is that because they’re secured rather than unsecured, they’re less risky than plain vanilla bank debt, which means that they constitute low-cost funding for the bank in question. And the second is that because the mortgages remain on the bank’s balance sheet rather than being securitized and sold off into the market, no one’s trying to sell mortgages in an environment in which the very concept is borderline toxic.

Now it’s true that covered bonds are, technically, mortgage-backed. But all the mortgages could default and go into foreclosure tomorrow, and so long as the bank remains in operation, the covered bond will pay out as normal. Similarly, if the bank blows up for some non-mortgage-related reason, investors in the bond will still get paid back in full. Their main risk is that the bank blows up because the mortgages blow up, and they’ll be left holding a bag of damaged loans – but because two things have to happen rather than just one, that risk is relatively low.

Could covered bonds be part of the solution to the current credit crisis? Paulson thinks so, and so do I. They’re not a panacea, by any means. But they certainly can’t do any harm, and they might be able to do some good.

Option overview

An option is a right to buy or sell an asset for a specified price and time.Let’s say you want to by a TV on sale at Wal-Mart. You drive there only to find out that it’s "sold out". So you go to the clerk and ask for a "rain check".

This "rain check" is a guarantee that you will get the TV for the sale price when they are back in stock. There may be an expiration date on the "rain check" for 1 month from the out of stock date.This rain check qualifies as an Call option.

You have the right to purchase the TV for the sale price up to 1 month regardless of how much the TV goes up or down in price during that period. You are the buying this call option and Wal Mart is the seller. The only difference of this rain check versus a real option is that there is NO value on this option and it is probably non-transferable.

Now, let’s use this same concept for a stock.

For instance, you want to buy Microsoft stock and it is trading at $50 a share. Instead of buying the stock, you decide to purchase a "right to buy the stock at 50" which will expire on 1/15/01. You would be willing to pay $3 for this right to buy Microsoft before 1/15/01 at $50.

On the other side of this deal, there is someone who is willing to sell you this right for you to buy Microsoft from him for 50. He wants $3 for granting you this contract.

Comparison table: Stock option VS Rain check for TV

Introduction

Profit loss VS Price graphs are by far the simplest and most powerful way to communicate the risk and reward assoicated with any option or option spread (two or more options).

Back to the Microsoft stock option example from above.

You decided to go ahead and buy the call option (right to buy) on on microsoft for 50 per share by 1/15/2001 for $3 per share.
The contract size is 100 shares.

Profit (loss) vs Price table

As we can see, you cannot lose more that the price you paid for the option of $300.
Your profits are same as if you had bought Microsoft stock less the option price.

Chart description
The PL vs Price graph consists of: Profit or (loss) of the position plotted on the Y-axis. Underlying price plotted on the X-axis. (underlying: is the stock, future, or index of the options)

The current price of the underlying is located in the center of the X-axis underlying price range.

Buying or Selling the Underlying:

These two graphs represent just buying or selling the instrument (stock, future, index).

They are simply 45 degree lines which intersect at the current underlying price.
For every dollar the underlying price moves up or down, there is an incremental profit (loss) movement. Selling the Underlying also is known for stocks is known as shorting the stock (selling the stock without first owning it).

Buying a call option:
(a call option is: a right to buy an underlying for a specific price and time period)

The above graph is shows the profit or loss of buying a call option for a range of projected underlying prices at expiration day for the call option.

Notice below that the loss is limited to the price of the call option if the underlying price at options expiration is LOWER than the current underlying price.

Profit and Loss moves incrementally (45 degree angle) if the underlying price at options expiration day is GREATER than the underlying price today.

Buying a put option:
(a put option is: a right to sell an underlying for a specific price and time period)

The above graph is shows the profit or loss of buying a put option for a range of projected underlying prices at expiration day for the call option.
Notice below that the loss is limited to the price of the put option if the underlying price at options expiration is HIGHER than the current underlying price.
Profit and Loss moves incrementally (45 degree angle) if the underlying price at options expiration day is LESS than the underlying price today.

Selling call or put options

The above graphs show the profit and loss at options expiration for selling a call or put.

Notice below that the losses for selling calls are puts are virtually UNLIMITED.
But the profit is limited to the price of the option.

 Recap, six option spread components:

Spreads
A spread is two or more of the above six components combined.
For example, if you combine buying a call and buying a put together, this forms a spread known as a straddle:

The straddle spread is a strategy which would profit if the underlying moved considerably
up or down. Remaining the same would cause a loss limited to the combined prices
of the call and put options.

This position could be reversed to selling a put and selling a call known as a Short Straddle spread.

The above Short Straddle position is a neutral strategy profitable if the underlying price remains the same. Maximum profit is the combined prices of the call and put options and maxiumum loss is unlimited.

Another common spread position is known as a covered call.
This is formed by buying the underlying and sell a call.

The covered call spread works precisely the same as the SELL PUT position.
Your maximum profit is the price of the call. Your maximum loss is the value of the underlying less the call you sold. You would make money so long as the underlying stayed the same or moved up.

Varying the Strike Price
Strike price is the price of the underlying that you have the "option" to buy or sell for.
For example, a 50 call would mean that you have a right to buy the underlying for 50 before a certain date.

All call and put options have a series of strike prices.
This series has a center as the current price of the underlying.

For example, if a stock is trading at 50.. the center strike price would be 50. This strike is also known as the "at the money" option.
Stock A with a current price of 50 has the following call options:

The 50 call would be the "at the money" call since it is closest to the underlying current price of 50.

An "in the money" call would be any call with a strike price LESS than the at the money call.

An "out of the money" call would be any call with a strike price GREATER than the at the money call.

Recapping the Call options chain:

The Put options chain is the call chain in reverse:

Put options are valued at the opposite of call options.
An "Out of the money" Put strike would be an "In the money" Call strike.

When we view the PL chart for varying CALLS, we see that the in the money calls have higher maximum losses, but a lower break even price.

The PL chart for varying PUTS show that the in the money puts have a higher maximum loss and higher break even price.

Selling varying call and put strikes are shown below:

Credit and Debit Spreads
A very common and effective 2 option spread strategy is the credit or debit spread.
This spread consists of buying one call option of a particular strike price and selling another call option of a different strike price. (You can
also do the same for puts.
The main difference between the credit versus debit spread is that in a credit spread, your sell option price will be greater than your buy option price giving you a net credit when you open the position. The debit spread buy price is greater than the sell price giving you a net debit when you open the position.
The call debit spread would be to buy an AT the money call and to sell an OUT of the money call. The PL graph would look like the following:

Notice how the call debit spread has a limited loss as the net option cost of buying and selling the calls. It has a maximum profit as the net difference in the strikes of both calls. For example, assume we buy a 50 call for 2 and sell a 60 call for 1. The maximum loss would be -1, and the maximum gain would be 10.

The Call Credit Spread consists of combining: (buy at call) + (sell in call)

The spread initially gives you a net credit of the sell option price less the buy price.
This is a bearish position which is profitable only as the price of the underlying goes down.
The maximum gain is the net credit of the option prices, the maximum loss is the difference in the option strike prices.

Put credit and debit spreads work the opposite way of Calls
For a Put debit spread we would: (buy at put) + (sell in put)

The spread would give us an initial cost of the difference between the buy option and sell option which would also be the maximum loss. The maximum gain is the difference in the strike prices.

The put credit spread is: (Buy at Put) + (Sell in Put)

It would give you an initial credit of the net cost of the two options with a maximum gain of the difference of the option strike prices. It is a bullish strategy profitable if the underlying price increases.

Option Component Abbreviation Table
Here is an easier way to summarize option components when combining them to construct spreads.

Ratio Spreads
The ratio spread is usually a three option spread strategy with 1 at the money option combined with 2 out of the money options.

Ratio Call = buy at call (bac) + 2 sell out call (sac)
Ratio Put = buy at put (bap) + 2 sell out put (sap)
Ratio Call Backspread = sell at call (sac) + 2 buy out call (boc)
Ratio Put Backspread = sell at put (sap) + 2 buy out put (bop)

The ratio call spread is formed with the options below:

[singlepic=23,430,250]

(Click Image to View)

The ratio call is profitable if the underlying goes down, stays the same or goes up slightly.

Using the above method, we can generate 4 different ratio spread combinations:

As we can see from the above graphs, backspreads have a lower maximum risk but smaller profit range.

4 Option Spreads
Most 4 option spreads form high probability of profit neutral strategies.
This high probability of profit comes from the statistical fact that the the underlying price will most likely remain nearly the same given a time limitation.
There two main types of four option spreads: The butterfly and the iron condor.
The main difference is that the iron condor combines both call and put options whereas the butterfly is call or put exclusive.

butterfly call = buy out call (boc) + 2 sell at calls (sac) + buy in call (bic)
butterfly put = buy out put (bop) + 2 sell at puts (sap) + buy in put (bip)
iron condor = buy out call (boc) + sell at call (sac) + buy out put (bop) + sell at put (sap)
iron condor (flat) = buy further out call (bOc) + sell out call (soc) + buy further out put (bOp) + sell out put (sop)

The butterfly call spread is made of the 4 call options below:

[singlepic=26,430,250]

(Click Image to View)

Notice how the butterfly spread is a neutral strategy being most profitable when if the underlying price stays the same.
Notice also how the loss is limited to the net option price.

The iron condor below uses both call and put options to form its spread:

[singlepic=25,430,250]

(Click Image to View)

This flat iron condor is essentially made up of two credit spreads (1call & 1put). You can visualize how both
credit spreads are overlayed together to form the iron condor.
Notice how the flat iron condor has range of maxiumum profit versus the butterfly having one point.

Overview of all spreads:

[singlepic=24,430,250]

Time decay in PL graphs
When plotting the profit and loss VS price of all of the above positions, we are using Profit and Loss on Options Expiration Day.
What about the Profit and Loss BEFORE expiration?
For any PL vs Price chart, you usually see two plots:
PL vs Price at Expiration AND PL vs Price Today.
Here is what the PL vs price today graph would look like as compared
to the PL at expiration for a the basic options:

Observe how the PL vs Price Today would obviously have a zero profit if you closed the position today and the underlying price stayed the same.
Also note the non-linear nature of a new undecayed option.

The blue undecayed spread line is plotted for all the different spreads below:

[singlepic=22,430,250]

(Click Image to View)

Conclusion on PL graphs
As you can see, PL vs Price graphs are a very effective to communicate how options work together to form specific trading strategies. When in doubt of how your spread strategy will react to any given underlying price change, plot it out on this graph. Once you get the hang of using these graphs, you will be on your way to making more informed options trades.

Long Call Butterfly

Long butterflies are entered when the investor thinks that the underlying stock will not rise or fall much by expiration. Using calls, the long butterfly can be constructed by buying one lower striking in-the-money call, writing two at-the-money calls and buying another higher striking out-of-the-money call. A resulting net debit is taken to enter the trade.

Limited Profit

Maximum profit is attained when the underlying stock price remains unchanged at expiration. At this price, only the lower striking call expires in the money.

Maximum profit = (intrinsic value of lower striking call at expiration) minus (initial debit taken) minus (commissions)
Limited Risk

Maximum loss is limited to the initial debit taken to enter the trade plus commissions.

Example

Suppose XYZ stock is trading at $40 in June. An options trader executes a long call butterfly by purchasing a JUL 30 call for $1100, writing two JUL 40 calls for $400 each and purchasing another JUL 50 call for $100. The net debit taken to enter the position is $400, which is also his maximum possible loss.

On expiration in July, XYZ stock is still trading at $40. The JUL 40 calls and the JUL 50 call expire worthless while the JUL 30 call still has an intrinsic value of $1000. Subtracting the initial debit of $400, the resulting profit is $600, which is also the maximum profit attainable.

Maximum loss results when the stock is trading below $30 or above $50. At $30, all the options expires worthless. Above $50, any “profit” from the two long calls will be neutralised by the “loss” from the two short calls. In both situations, the butterfly trader suffers maximum loss which is the initial debit taken to enter the trade.

Long Put Butterfly

The long butterfly trading strategy can also be created using puts instead of calls and is known as a long put butterfly.

Short Butterfly

The converse strategy to the long butterfly is the short butterfly. Short butterfly spreads are used when high volatility is expected to push the stock price in either direction.

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To setup an iron condor, the options trader sells a lower strike out-of-the-money put, buys an even lower strike out-of-the-money put, sells a higher strike out-of-the-money call and buys another even higher strike out-of-the-money call. This results in a net credit to put on the trade.

Limited Profit

Maximum profit is equal to the net credit received when entering the trade. Maximum profit is attained when the underlying stock price at expiration is between the strikes of the call and put sold. At this price, all the options expire worthless.

Limited Risk

Maximum loss is also limited but significantly higher than the maximum profit. It occurs when the stock price falls at or below the lower strike of the put purchased or rise above or equal to the higher strike of the call purchased. In either situation, maximum loss is equal to the difference in strike between the calls (or puts) minus the net credit received when entering the trade.

Example

Suppose XYZ stock is trading at $45 in June. An options trader executes an iron condor by buying a JUL 35 put for $50, writing a JUL 40 put for $100, writing another JUL 50 call for $100 and buying another JUL 55 call for $50. The net credit received when entering the trade is $100, which is also his maximum possible profit.

On expiration in July, XYZ stock is still trading at $45. All the 4 options expire worthless and the options trader gets to keep the entire credit received as profit. This is also his maximum possible profit.

If XYZ stock is instead trading at $35 on expiration, all the options except the JUL 40 put sold expire worthless. The JUL 40 put has an intrinsic value of $500. This option has to be bought back to exit the trade. Thus, subtracting his initial $100 credit received, the options trader suffers his maximum possible loss of $400. This maximum loss situation also occurs if the stock price had gone up to $55 instead.

To further see why $400 is the maximum possible loss, lets examine what happens when the stock price falls to $30 on expiration. At this price, both the JUL 35 put and the JUL 40 put options expire in-the-money. The long JUL 35 put has an intrinsic value of $500 while the short JUL 40 put is worth $1000. Selling the long put for $500, he still need $500 to buy back the short put. Subtracting the initial credit of $100 received, his loss is still $400.
Commissions

It is important to note that commission charges weigh heavily in a condor trade. This is because there are 4 legs involved in this trade and profit is made by writing out-of-the-money options with very low premiums. To reduce the impact of commissions on profits, one may wish to trade options that expire in 2 to 3 months instead of trading the near month options.

To setup an iron butterfly, the options trader buys a lower strike out-of-the-money put, sells a middle strike at-the-money put, sells a middle strike at-the-money call and buys another higher strike out-of-the-money call. This results in a net credit to put on the trade.

Limited Profit

Maximum profit is attained when the underlying stock price at expiration is equal to the strike price at which the call and put options are sold. At this price, all the options expire worthless and the options trader gets to keep the entire net credit received when entering the trade as profit.

Limited Risk

Maximum loss is also limited but significantly higher than the maximum profit. It occurs when the stock price falls at or below the lower strike of the put purchased or rise above or equal to the higher strike of the call purchased. In either situation, maximum loss is equal to the difference in strike between the calls (or puts) minus the net credit received when entering the trade.

Example

Suppose XYZ stock is trading at $40 in June. An options trader executes an iron butterfly by buying a JUL 30 put for $50, writing a JUL 40 put for $300, writing another JUL 40 call for $300 and buying another JUL 50 call for $50. The net credit received when entering the trade is $500, which is also his maximum possible profit.

On expiration in July, XYZ stock is still trading at $40. All the 4 options expire worthless and the options trader gets to keep the entire credit received as profit. This is also his maximum possible profit.

If XYZ stock is instead trading at $30 on expiration, all the options except the JUL 40 put sold expire worthless. The JUL 40 put will have an intrinsic value of $1000. This option has to be bought back to exit the trade. Thus, subtracting his initial $500 credit received, the options trader suffers his maximum possible loss of $500. This maximum loss situation also occurs if the stock price had gone up to $50 or beyond instead.

To further see why $500 is the maximum possible loss, lets examine what happens when the stock price falls below $30 to $25 on expiration. At this price, only the JUL 30 put and the JUL 40 put options expire in-the-money. The long JUL 30 put has an intrinsic value of $500 while the short JUL 40 put is worth $1500. Selling the long put for $500, and factoring in the intial credit of $500 received, he still need to fork out another $500 to buy back the short put worth $1500. Thus his maximum loss is still $500.
Commissions

It is important to note that commission charges weigh heavily in an iron butterfly trade. This is because there are 4 legs involved in this trade compared to the simpler options strategies like the long call or vertical spreads which only involve 1 or 2 legs. To reduce the impact of commissions on profits, one may wish to trade options that expire in 2 to 3 months instead of trading the near month options.

I run a free Singapore Dividend Stock Tracker available for everyone’s perusal. It  contains Singapore’s top dividend stocks both blue chip and high yield stock that are great for high yield investing. Do follow my Dividend Stock Tracker which is updated nightly  here.

I have not done any call BWB’s for several reasons

1.I have been trying to keep them consistent for learning purposes. Had I done them with calls I would be hearing “why didn’t I do them with puts?”

2.During periods of low volatility it is harder (because of skew) to split the strikes further apart with calls than puts.

Many, many people have been asking about the difference between a butterfly spread and a broken wing butterfly. Others have also written that they understand the difference in theory but not practice. In an attempt to clarify the matter, something I am not particularly good at, I will explain the two trades’ similarities and differences. First, let me begin with the definitions. At first glance, the two positions will sound very similar in construction, and they are, but that is where the similarities conclude as they operate dramatically different in real-world application and execution.

Note: In the examples used below I will illustrate with SPY options going off of the closing marks from a leading broker. I do this as these tend to be between the bid-ask spread, which is about the same as the spread”s mid-point. I have found that if by being patient, you can usually get filled about half the time at the mid-point, and do not need to give up the vast amount of slippage most often associated with single options of vertical spreads. This is just a rule which is not a guarantee but does occur for those who are patient enough and experienced enough in trading to trade this way. The options being used are December puts with about 33 days until expiration.

Butterfly Spread – A long butterfly spread can be thought of as the simultaneous purchase a closer to ATM vertical call/put spread and the sale of a further OTM vertical call/put spread where the two spreads share a common strike. The strike shared will be at the sale portion of each vertical spread.

An example of a butterfly would be the following:
Buy 10 contracts of the 139-138 put spread (buy 139 put and sell 138 put), and sell 10 contracts of the 138-137 put spread (sell the 138 put and buy the 137 put) for a net -$0.20 debit.

Broken Wing Butterfly [BWB] – A long BWB spread can be thought of as the purchase of a smaller distance between closer to ATM strikes call/put spread and the simultaneous sale of a further OTM larger distance between strikes call/put spread. In this spread, just like the traditional butterfly, the two spreads will share a common strike almost always on the sale portion of both spreads.

An example of a BWB would be the following:
Buy 10 contracts of the 139-137 put spread (buy 139 put and sell 137 put), and sell 10 contracts of the 137-133 put spread (sell the 137 put and buy the 133 put) for a net $0.05 credit.

How Each Spread Works

Butterfly

By purchasing a closer to ATM spread, you are hoping the underlying moves in the direction of the short strike price, in this example it would be the 138 strike. With the short spread you want the underlying to close ATM or OTM, in this case it would be at the 138 strike or higher (with puts).

In our example we are long a put spread where we want the index to close at 138 or lower and short a put spread where we want the index to close at 138 or higher. The two of the spreads are worth their maximum amount simultaneously at 138.

Butterfly spreads tend to not open dramatically until just before expiration because of the very real possibility of the stock/index moving away from the center strike by expiration. The less time the index has to move away from strike, the more the spread is worth.

Typically, the most that can be lose on a butterfly spread is the amount paid for the spread. This may sound like a benefit; however, when you consider in this example the spread cost us $0.15 for a maximum profit of $0.85 ($1 maximum value – $0.15 cost), and the stock/index has to close very close to exactly 138, the debit can be very expensive.

Broken Wing Butterfly

By purchasing a closer to ATM spread you are hoping the underlying moves in the direction of the short strike price, in this example it would be the 137 strike. With the short spread you want the underlying to close ATM or OTM, in this case it would be at the 137 strike or higher (with puts).

In our example we are long a put spread where we want the index to close at 137 or lower and short a put spread where we want the index to close at 137 or higher. The two of the spreads are worth their maximum amount simultaneously at 137.

BWBs tend to open up (begin to increase in value) sooner than a traditional butterfly because the distance between the strikes is greater than the traditional butterfly, and because the furtherest OTM option purchased has less value that can be lost due to time decay.

BWB Compared to a Butterfly

On the surface a traditional butterfly may appear to be the better trade because of the limited loss of the net debit. However, because of the limited range between the strikes, the relatively expensive cost of the trade, and the fact that the trade tends to not open up until very close to expiration the BWB may be the better trade.

The BWB does have an area of loss similar to a short vertical spread because the spread sold is wider than the spread purchased; however, this is usually only a problem the last few days of expiration if you let the underlying go dramatically through the most far-out-of-the-money strike without adjusting the trade. Typically, because of how options work in real-life, the deltas and gammas associated with the closer to ATM (or further ITM) spread offer enough protection for the short spread even though it is wider and theoretically has some risk.

If the BWB is placed at the right strikes, the strikes are spread apart correctly and the correct amount of time remaining until expiration is entered into, the trade is difficult to lose money with. Couple that with entering into the trade for close-to-zero cost (compared to the butterfly) and the position is hard to beat.

Think of it this way – If you buy a butterfly the spread has to close near the center strike in order to make money. When doing a butterfly using OTM puts you will need the stock to sell off just the right amount to make money. The BWB, however, can sometimes make money if the stock goes in the correct direction, stays flat and even if it goes ever so slightly in the wrong direction. That is the power of the BWB compared to a traditional butterfly, or any other spread for that matter. It is also a reason why most of the more successful floor traders I was familiar with did quite a few of these trades as their core strategy.

An example of this would be fast forwarding the clock until Monday before expiration. With the index at approximately 139, an area where if the market closed there on expiration both spreads would expire worthless, the butterfly would be trading for -$.25 (a $0.05 profit) and the BWB would be trading for approximately -$0.50 (a $0.55 profit). In other words the butterfly makes $0.05, perhaps not even enough to cover commissions, and the BWB is up $0.55 (or $550 on 10 contracts).

The trades are even more dramatic if the stock is at the center strike where the traditional butterfly would be trading for about the, believe it or not, same -$0.25 (or $0.05 profit) and the BWB would be trading for about $-0.90 (or a $0.95 profit, or $950 on 10 contracts). Even if the index fell several dollars through the center strike price 9something you don”t want on expiration week with the BWB) you would still likely be up money.

Summary

Take a moment to think about this. If the spread is OTM the week of expiration (or expiration day) both spreads may expire worthless. The BWB was put on for a small credit so you will be profitable by a smidgen, whereas the traditional butterfly was put on for a debit and will result in a loss.

If the stock is at the first buy strike with a week to go until expiration the butterfly is up (in this example using today”s prices and current volatility measurements) perhaps $0.05. The BWB, however, would be up $0.55.

If the stock is at the center strike the butterfly is still only up a smidgen because of the probability that the stock will close at the “sweet spot” and the furthest OTM is decaying. The BWB, however, is now trading for roughly half of its maximum value and perhaps half of the position can be taken off and the other half be played with.

If the stock is at the bottom strike roughly the same profit and loss will occur has the stock been at the top strike (using puts). Yes, if you allow the stock/index to fall through the bottom strike with puts (or go above the top strike with calls) you run the possibility of a loss if you do not adjust the position. The good news for those wanting to trade the BWB, though, is that everyday you can look at the position and determine where the area of maximum profitability is, and where you would theoretically start to lose money. With that knowledge before the fact you can trade the position accordingly.

I have to state a few things for clarity and your protection. The trade above was used for example purposes only and is not the best BWB I saw by any means. I used this as a good example, not as a good trade. Please do not trade off of this. This is not a recommendation to invest in any security or derivative. Also, though it is my opinion and favorite strategy to trade, it may not be the best strategy for you. I love this trade dearly, but if you do not understand it thoroughly I would strongly suggest staying away from it until you do learn how to trade it. Many market-maker friends I had on the floors made fortunes with minimal actual risk (compared to theoretical risk) trading these type of trades, but some novices lost fortunes mimicking them not knowing what they were doing themselves. If you like them, get to know them well and they should serve you well. If you don’t understand the difference between theoretical option movement and real option movement or the strategy, then I suggest you get some more education no matter what strategy you trade.