How to Trade Butterfly Option Spreads (Part 2)

01/26/2010 12:01 am EST

Focus: OPTIONS

This is the second in a series of articles on the topic of butterfly spreads, and will visually show how to place a call butterfly spread using the TradeStation platform. The actual trade is not meant to be a trade suggestion.

The first of many figures below shows the daily chart of the underlying, on which a butterfly call spread will be placed. Observe that the underlying has closed at 42.55 and that I am anticipating it to stay range-bound between the 45 level and the 41 level. Whether that will happen remains to be seen, yet for educational purposes only, let us go along with the assumption that the underlying most likely will be by February 2010 expiry somewhere close to the 43 level.


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The second figure shows the step of switching from one option strategy to another. The default setting on TradeStation is "Buy" on the first button and "Covered Call" on the second. In order to place our butterfly, the selection needs to be changed from "Covered Call" to "Btfy Call." The very first button does not need to be changed from buy to sell because in fact we are buying our butterfly spread for a debit. This is the very first click we ought to do prior to proceeding to the next click.


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The next step involves going to the “View” tab and requesting the display of an additional component of the option analysis window. Observe in Figure 3 below that by default, only Asset Pane and Options Pane are checked off. In order for us to be able to trade spreads, we need to also check the Spread Pane, as shown in Figure 3.


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The figure below shows three things going from the top to the bottom. The Asset Pane reads from left to right with the following data: First item being the ticker, which is whited out since this example is for educational purposes only. The second is the last price of the underlying, the net change in points, the high colored in light green signifies the highest the underlying has traded the day I had placed this trade. The next one is the change in percentage, which on that day was only 0.31%, followed by the low of the day, colored in light red. The additional info on the Asset Pane relates to the volatility.

The second component of the TradeStation option analysis window is the actual option pane. It displays the following data, which are completely customizable: Symbol of individual options, Volume, Open Interest, High, Gamma, Low, Bid, Delta in light blue, Ask, and Strike price. All this information pertains to the calls, and then it repeats on the right side for the puts. However, in this example, I am addressing a call butterfly, so I will solely focus on the call side of the option chain.

Additional info on the option pane that needs to be addressed is the dark blue line with a small square box containing a plus sign in it. When we click on the plus, it becomes a minus sign, displaying the various strike prices. I have selected only five strike prices, those between 40 and 45, and have blocked all others.

The third part of the TradeStation option analysis window is the Spread Pane, which is currently displaying only two months of data: January options, which were expiring in two days at the time of writing, and February. There were other months available, yet I have selected less info.

Finally, I can address our butterfly call spread, which involves the 41/43/45 strike prices. As I mentioned in part one of this series, the wings are bought (41 and 45 calls) while the body (43 call) is sold. Observe that the platform ensures that there is not a mistake as to which strike prices are involved. However, be aware that this butterfly spread has a two-point wing span. This info could be verified by looking at the button next to the two that I have already addressed, "Buy" and "Btfy Call." The third one reads "2:2 Strikes." Initially, the default was "1:1 Strikes."


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Also observe that in the Spread Pane of the TradeStation option analysis window is the brown line reading 41/43/45. This line matches the strike prices, which are involved in the spread with the Greeks. Self evidently, the light blue box displays the aggregate of our butterfly call spread. The fact that the delta of $9.17 is positive means that the position has a slightly bullish bias. The cost of placing the trade with ten contracts per leg is only $570, while the maintenance is $1,430. By the way, I do not intend to hold this position until expiry. Over the next few weeks, I will be tracking this position with subsequent articles.

By Josip Causic of Online Trading Academy

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