Butterfly Trades with Weekly Options

09/10/2012 9:00 am EST

Focus: OPTIONS

Dan Passarelli

Founder, Market Taker Mentoring, LLC

Dan Passarelli, a featured speaker at this week’s Forex & Options Expo, explains how weekly options can be used for butterfly option trades.

Weekly options have been the topic of our blog many times before. 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 option strategies.

(If you need to find out more about weekly options or other option strategies, feel free to visit the options education section on MoneyShow.com.)

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 consider its components briefly. It is constructed by establishing both a credit spread 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 lifespan. In the case of the longstanding monthly duration option cycles that 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 briefer periods of time.

Dan Passarelli can be found at MarketTaker.com.

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