Lessons from the Pros

Butterfly: Part V

This newsletter is the second to last in a series of articles that have addressed, in greater detail, the option strategies known as Butterflies. Specifically, here I will present the steps involved in placing a Put Butterfly on TradeStation.

As a brief recap, typically the option trader would place Butterfly spreads when they are not anticipating huge movement within a specific time frame. A regular Butterfly is essentially a combination of a debit and a credit spread. However, both types of spreads must be built by the same option class; either calls or puts. In other words, there are Call Butterflies and Put Butterflies. In one of my previous articles, Butterfly: Part II, I gave an example of a Call Butterfly. Now is the time to do the same for the Put Butterfly.

A Put Butterfly spread is made up of a debit put spread and a credit put spread. Many times, reference to a debit put spread is made by using different semantics such as a long vertical put spread, whereas a credit put spread is also known as a short vertical put spread. Some option traders label a short vertical put spread a Bull Put, while a long vertical put spread for them is a Bear Put. Regardless of the labels used, one should be aware of the fact that the Butterfly works the best in a sideways environment as our aim is to profit from time erosion.

Once again, a Put Butterfly is made up of a debit put spread (Bear Put) and a credit put spread (Bull Put). By the way, some brokerage houses identify a debit put spread as a long vertical put spread and a credit put spread as a short vertical put spread.

Next, let me point out what is being bought and sold. The table below shows the components of a Put Butterfly.

Generally, a Put Butterfly is constructed by buying a lower strike price (Strike A) put, selling two puts at the middle strike price (Strike B), and buying one at the higher strike price (Strike C).

An additional clarification must be made in reference to what is the wing and what is NOT. Strike A and Strike C are called the Wings, while Strike B is called the Body.

Now that I have given the basics on the Put Butterfly, let me proceed to the actual steps involved in placing a Put Butterfly on TradeStation. After selecting an underlying that is trading in a sideways channel, we move on to multiple clicks on the platform.

The figure below shows the step of switching from one option strategy to another. The default setting on TradeStation is "Buy" on the first button and "Covered Call" on the second. In order to place our Butterfly, the selection needs to be changed from "Covered Call" to "Btfy Put." The very first button does not need to be changed from buy to sell because in fact we are buying our butterfly spread for a debit. This is the very first click we ought to do prior to proceeding to the next click.

Figure 2

The next step involves going to the View Tab and requesting the display of an additional component of the Option Analysis window. Observe in Figure 3 below that by default, only Asset Pane and Options Pane are checked off. In order for us to be able to trade spreads, we need to also check the Spread Pane, as shown in Figure 3.

Figure 3

Figure 4 shows three things going from the top to the bottom. The Asset Pane reads from left to right with the following data: First item being the ticker, which is whited out since this example is for educational purposes only. The second is the last price of the underlying, the net change in points, the opening price; the high colored in light green signifies the highest the underlying traded the day I had placed this trade. The next one is the change in percentage, which on that day was negative 1.13%, followed by the low of the day colored in light red. The additional info on the Asset Pane relates to the volatility.

The second component of the TradeStation Option Analysis Window is the actual Option Pane. It displays the following data, which are completely customizable: Volume, Open Interest, High, Low, Bid, Delta in light blue, Ask, Intrinsic is light yellow, and Strike price. All this information pertains to the Calls, and then it repeats on the right side for the puts. However, in this example, I am addressing a Put Butterfly so I will solely focus on the put side of the option chain.

The third part of the TradeStation Option Analysis Window is the Spread Pane, which is currently displaying only two months of data: March options which were expiring in 24 days at the time of writing, and April. There were other months available, yet I have selected less info.

Now, let me briefly address a Butterfly Put spread which involves the 610/620/630 strike prices. Observe that the platform ensures that there is not a mistake as to which strike prices are involved. This Butterfly spread has a single-strike wing span. Also, observe that in the Spread Pane of the TradeStation Option Analysis Window is the brown line reading 610/620/630. Its aggregate Delta is negative 5.32 per contract which means that the position has a bearish bias.

Figure 4

Figure 5 represents the actual placing of the trade. I right clicked on the brown line 610/620/630 mentioned above and the rectangular gray box appeared. Then I selected the top choice on it, specifically "Place Order." The platform did not know if I was trying to open a new position or close an existing one, so I was given the choice. I have highlighted the line reading "To Open Position…" After clicking on that, another box appeared: "Option Spread Order Bar." See Figure 5. It is in this box that I must specify whether I agree with the price. Observe that there are two boxes within the "Option Spread Order Bar." One is empty and has the words "Limit Price" above it, while the second one says "P: 1.300" indicating the debit or trade cost. Once I have clicked on the P button, the Limit Price box gets filled and I can proceed with placing the order. On this trade, my maximum loss is $1.30 per contract while my max profit is (10 – 1.30) $8.70. By the way, 10 comes from the spread width.

Figure 5

The very last step, involves proofreading the order and confirming it. Once the YES button is clicked, the trade is sent to the market; hence, make sure to take time to read every single line in the confirm box. Do not skip any of it – the contract size, the action buy or sell, route, duration, or the price.

This article has visually shown how to place a Put Butterfly spread using the TradeStation platform.

- Josip Causic