Trading Butterflies on Weekly Options

01/03/2012 10:35 am EST

Focus: OPTIONS

Dan Passarelli

Founder, Market Taker Mentoring, LLC

Weekly options are quickly gaining in popularity, and for traders who like to use the butterfly spread strategy, the shorter duration can be very useful and provide several distinct advantages.

Weekly options have been the topic of several MoneyShow.com articles over the past month.  Despite this topic being the trendy subject and in the forefront of many discussions, it is helpful to recognize the functional flexibility this dramatically shortened lifespan brings to a variety of strategies.

As an example, consider the case of a frequently traded spread vehicle, the butterfly option trade.  For those first encountering this strategy, it is helpful to briefly consider its components. It is constructed by establishing both a credit and a debit spread sharing a central strike price. It can be constructed in either all puts or all calls.

Butterflies can be designed to be either a non-directional or directional trade strategy. Functional characteristics include: negative Vega, variable Delta, and accelerating Gamma and Theta during its life span.

See related: Know Your Option “Greeks”

In the case of the long standing monthly duration option cycles, which had heretofore been available, these characteristics developed over weeks to months and reached their final expression during the week of option expiration.

These functional characteristics have limited the utility of butterflies over brief duration moves occurring early in the options cycle. Many butterfly traders have had the experience of correctly predicting price action early in the cycle only to have the butterfly deliver little, if any, profit.

The short, nine-day duration of the weekly options has dramatically accelerated the pace of butterfly trading as the changes begin to occur literally over the extent of a few hours. As such, it is possible to gain the advantage of this trade structure over brief directional moves or in the case of non-directional traders to have market exposure for shorter periods of time.

By Dan Passarelli of MarketTaker.com

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