Do you know what it feels like to sell a weekly vertical spread (DANGER!) only to see the market rip towards your short strike and tear your face off? Alternatively, have you sold an Iron Condor right before the market went racing higher or lower?
Did you adjust or just panic and get out only to watch the market reverse before expiration? Trust me, I know the pain. I’ve been there. Nobody ever said trading would be fun, did they?
Fast directional movement is one of the biggest challenges we face as non-directional options income traders. While there are numerous ways to avoid, hedge, or adjust for market movement, an even simpler way is to begin with a position that doesn’t care what happens.
Specifically, I’m talking about the Consistent Income Butterfly (CIB or CI Butterfly) that I’ve been trading since last summer. You’ve also seen the CI Butterfly in the Weekend Market Commentary. The CIB is more dynamic than the Migrating Butterfly and has a much greater potential profit with more less delta risk. The CI Butterfly could be traded with as little as $5,000, but $7,500-$10,000 per position is recommended.
The CIB is a non-directional, market neutral Butterfly options strategy. The trade begins with a very flat T+Zero line and moves with the market to avoid big losses. While the CIB isn’t the simplest trade in the world and requires some active management, the risk/reward is very favorable. I’m a pretty risk adverse trader and that played a big role in how I designed the trade.
The image below shows a CI Butterfly shortly after the trade was initiated. In this case, price began higher and traded into the center of the Butterfly. Notice that the trade has very little directional risk.
Risk and Position Comparison:
In the images below we’re looking at a typical Iron Condor in $SPX and the CI Butterfly. One of the big things to note is that the absolute dollar risk in the CIB is slightly greater than the Iron Condor. However, the potential profit is significantly greater.
One of the reasons I began trading Butterflies in general is that they have the potential to provide a much more favorable risk:reward ratio. Borrowing from what I learned as a trend following trader, I always look for ways to maximize winning trades. The CI Butterfly provides an opportunity to win many times the intended loss in the right market environment.
CI Butterfly Options Trade:
If you revisit the CI Butterfly shown above, you can see the initial risk is slightly over $1,000 with the potential to make close to $4,000. While we’re targeting a very small portion of the potential gain, a good market environment can make the trade much more profitable. The image below shows another CI Butterfly that is close to expiration.
CI Butterfly Trading Philosophy:
The rules provided here aren’t all inclusive, but they do give you a general idea of how the trade works. The trade begins with a 50 point wide $RUT Put Butterfly with a long $IWM call (you could also use an Iron Fly). I target an initial risk:reward of around 25-32% for the starting Butterfly. For example, a Butterfly that has 50 point wings and costs 11.00 has a risk:reward of 11/(50-11) = 11/39 = 28.2%.
The center of the Butterfly is positioned 10-20 points below the money, which gives the trade more room on the downside and a slightly bearish bias. Due to the slight bias, I make an effort to time my entry. Timing the trade perfectly will not make or break the trade, but it can make adjusting the trade easier.
Initiate the position 40-50 days to expiration. I was originally trading the strategy with 50-60 days to expiration, but found that I was frequently spending the first 10 days losing money. As a result, I moved the entry window back and generally enter 45-50 days out.
If you’re looking to time your entry more dynamically, initiating the trade earlier tends to work better when both implied and realized volatility are lower.
If the market trades lower, the Butterfly and long call are closed and rolled lower. On the upside, I add to the position up to two times before rolling up the lowest Butterfly. The philosophy behind the trade is that we stay smaller and more nimble when the market is moving down and willing to take on a little more risk on the upside. Since the trade is designed to stay below the money, a pull back generally helps the position.
The image below shows a CI Butterfly trade after two upside adjustments:
A more conservative way to trade the position is to add only once on the upside and then roll. By only adding to the position once, you reduce the dollars at risk and keep the greeks smaller overall.
The absolute max loss I’m willing to take on a CI Butterfly is around $300, which is similar to my target gain. Like most higher probability options trades, the trade wins most of the time so a 1:1 risk:reward ratio keeps the trade profitable.
It’s also worth noting that a $250-$300 gain/loss on a $10,000 account represents 3% of capital, which is the target return for the trade.
Click here to check out the Premium Course that covers the CIB Trade in Detail
I’ll be posting a recap of the October Butterfly once we’re through the cycle because the strategy has evolved over the past year. The links below are some examples of previous trades, but keep in mind that my butterfly adjustment rules have changed slightly.
We’re barely scratching the surface here and I’ll be posting additional information about the CI Butterfly options trade going forward. Let me know what questions you have in the comments below or via email. Your feedback allows me to make the discussion both more relevant and helpful for you!
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