Photo: Liza Summer

When should you trade butterflies?

Forty-five days to expiration is optimal. Anywhere between 30-60 days left to expiration is a great time to be entering these trades. A Butterfly is made up of two Short Calls at-the-money. Long calls should be at or near the expected move.

navigationtrading.com - The Best Way To Trade Butterfly Spreads - Navigation Trading

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Make Your Bookie Cry And Pull The Hair By Generating $23,187

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Welcome back to another lesson from NavigationTrading!

In this lesson, we’ll be going over Butterfly Spreads.

Why do we trade Butterflies?

Defined Risk – We are able to define exactly the amount of money that we want to risk on the trade, before we even enter. IRA Eligible – You can trade a Butterfly in an IRA account, or in a margin account. Delta Neutral – We do not have to make a directional assumption on the underlying stock, or ETF, before we put the trade on. We like to enter them as delta neutral trades. Positive Theta – This means, as the options decay, as they get closer to expiration, we collect that positive theta, which is putting money into our account.

Choose Your Trading Vehicle

The first thing that we’re going to do is choose a liquid underlying. Only use trading vehicles on the NavigationTrading Watch List. If you don’t have a copy of our watch list, go to navigationtrading.com/free-member, enter your email address and we’ll send you that watch list for free. You want to make sure that you’re in a vehicle that has a lot of volume. This allows you to get in and out of the trade very easily. Also, be sure the options have tight bid/ask spreads, so it’s not eating up your profits. Our preference at NavigationTrading is to look for opportunities to trade an index, or an ETF first, and then I look at stocks second.

Choose a Vehicle with High Implied Volatility

You want to choose a vehicle with high implied volatility, if possible. When we go to the platform, you’ll see that we are in a very low implied volatility environment right now, so there’s not a lot to choose from, as far as high implied volatility options. However, if at all possible, you want to start with high implied volatility. The way that we measure implied volatility, is by looking at the implied volatility rank, and the implied volatility percentile. We want to make these trades, if at all possible, when the I.V. rank or I.V. percentile is over 50.

Setting Up the Trade

When you begin to set up your trade, you’ll need to choose your timeframe.

How many days to expiration do you want your options to be, to enter the Butterfly trade?

Forty-five days to expiration is optimal. Anywhere between 30-60 days left to expiration is a great time to be entering these trades.

Choose Your Strikes

A Butterfly is made up of two Short Calls at-the-money. Long calls should be at or near the expected move. I’ll explain that more when we get to the Platform. As a tip, you can set up a Butterfly Spread with all Puts or all Calls. We like to start with Calls. As long as you’re consistent when you set them up, that’s all that really matters.

Platform Example

Let’s go to the thinkorswim platform and take a look. The vehicle that we’ll look at today is SPX. As you can see from the indicator below the chart, volatility is very low. We’re using the NavigationTrading Implied Volatility Indicator, which shows the I.V. rank in green, and the I.V. percentile in yellow. We really like to see at least one of those above 50, when we enter this type of trade. There’s really not a symbol out there, at the time of this tutorial, that has a high implied volatility.

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