Closing A Wide Iron Butterfly Option Trade for a Profit

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Iron butterfly: In tonight's video update we're going to go over all the trades that we made on Tuesday, September 15th. So, today we had some pretty good activity this morning, closing out positions and then making some adjustments that we had talked about with elite members on the strategy call on Sunday night.

Most of the stuff that we're closing out is either stuff that we had on that were earnings trades that were adjusted and rolled like KSS or everything else is pretty much automatic closing orders where we're getting closer to expiration so we want to get some of these things off the books and take in profits.

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iron butterfly

So, first one that we closed out of tonight is the big Iron Butterfly that we had in BA. Now, this thing was a pretty massive Butterfly, and we took in almost a thousand dollars in credit on this one. Very wide strike points and you could have made them a little bit tighter, and I know some people did.

But, the whole idea here is that we're trying to outlay cash and use what the market gives us. So, we had high implied volatility, stocks were falling. Had an opportunity do to this very wide Butterfly in BA to get a massive credit and we bought it back today for a $750 debit, and that still left us a profit about $219 on the actual trade.

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Now, when we look at a chart of BA, you can see most of the profit came from the implied volatility dropping. We were patient enough to wait, haven't traded this thing all year, and got our one opportunity this year to trade this when implied volatility was in the 100th percentile. Now that it's dropped back down to 32nd percentile the stock has moved higher against our position but, all things considered, it's, you know, pretty much gone nowhere.

And, we had a nice profit just purely because of implied volatility and time decay which worked out in our favor. As far as other trades that we did, we did close out of part of our position in FXE, mainly just the SP or the September options in FXE. And, we just want to get these off the books with expiration coming, there's no need to continue to hold this.

We already have positions in October, so this was just a very simple closure. We had a profit on the books, wanted to take that off, and bought it back for 305 debits, banking about $38. For KSS, this was a trade that was an earnings trade that, unfortunately, just went against us from the beginning, so there was nothing we could do about it.

This one is one that was very similar to John Deere which we traded last week. And, you can see, that after earnings the stock [gapped 00:02:16] more than expected and then just continued to ride down. It never kind of turned around, and came back inside of our range. We did end up rolling the trade for credit, and that helped, again, minimize some of the loss potentials in the stock.

So, here are the actual orders that we had just so that you guys can see this. But, our original trade here, this earnings trade or opening trade, was back on August 12th for a $272 credit. Now, had we done nothing, obviously, and kept that position and rolled it for no credit, then we would have had a much greater loss than we have right now.

But, since we made an adjustment and rolled the strikes out to the next contract month, we added a $78 credit on the PUT side, and the CALL side added a $75 credit. And, so again, that helps buffer our position by about $125, $150 or so, and gives us a lot of movement in our break-even prices.

Now, all we can do, in this case, is just hopefully the stock comes back around and, you know, makes a turn back around the at least short-term and partial, and gives us an opportunity to get out of the trade with a smaller loss or even a profit. But, in this case, with KSS, you know, it never really happened.

Never materialized, the stock market fell, everything else fell and this thing, you know, got beat down in the process. All right, so the last trade that we closed off today was our VXX trade. So we got out of VIX yesterday, but VXX was another one that we had in October. The 36/37 CALL spread we bought back for just eight cents.

Again, holding this position all the way through October for another eight dollars in premium doesn't make sense. So, we took a nice $60 profit on that. I mean, honestly, I could trade these volatility products all day long if we had the opportunity, but now that we saw that huge spike in implied volatility, we were selling options all the way out here at 36 and above.

So, we still left ourself a lot of room for the market to expand, things to get crazy, and still make some money, and this is why I love trading options this way, especially short volatility like this because it's so predictable. And, I think, even though we did, you know, some fairly large positions in VXX and VIX this time around, the next time that we get a pop in implied volatility, we're definitely going to scale it just a little bit more aggressive because these tend to be some of the highest probability trades that are out there.

Just purely trading volatility to the downside. So, the one adjustment trade that we did have today was rolling out our current straddle in EEM out to October. So, all we did is we rolled both the CALL side and the PUT side in separate orders, you could have done it in one order, but we like to do them in two orders, and you do both sides out to the next contract month for credit.

So, in this case, we used the calendar spread to roll out the call side. Again, we're sticking with our same strike at 32. We're just extending the trading timeline, changing the whole position from September to October, staying with that same short strike at 32 on both sides. By rolling it out to October, we increased our credit 42 cents.

Same thing on the PUT side. By rolling it out to October, we increased our credit on the PUT side by 52 cents. That means that we almost took in an extra dollar in premium, which helps widen out our break-even points on EEM. Now, the reason that we wanted to do this is one; we want to stay in the stock heading out to the next contract month.

Implied volatility, though, just below the 50th percentile. Still, makes sense to do this because it gives us good exposure into another big ETF that's pre-liquid. And again, the stock's not too far off from where we want it to be. We want it to be, you know, somewhere centered around 32 here, but with our credits that we've taken in, we've got a break-even price that's, pretty much, about where the stock is trading right now.

So, we're still on the dance-floor, if you want to call it that. And I like the opportunity to just get a little bit more time, see a little bit more drop in implied volatility and hopefully, just maybe a slight move down in emerging market stocks. That would help out with our position. So, here's what the profit loss diagram looks like now with the new position out in October.

Let me go out to the next expiration. And you can see. Our break-even price is much higher than that; it's up around 35. So, now we've got a lot of credit built into this position, which helps out. And again, we're slightly bearish on EEM, but we'd love to see just a continual drop in implied volatility.

That would help more than just the directional move in the stock. So, in this case, with a stock like EEM, it makes sense to roll this thing out to the next contract month. And, we're going to try to do the same thing with our other position at EWW. We didn't get filled in rolling that one out to the next contract month, but that's going to be, very much, in the same vein of what we did here tonight with EEM.

As always, if you guys have any questions, please let me know in the comment box right below this video. And, till next time, happy trading.

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. In 2018, Option Alpha hit the Inc. 500 list at #215 as one of the fastest growing private companies in the US. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and three children.