Saturday, February 1, 2014

aapl butter

aapl is a well-known "pinner." that is to say, on some friday afternoons it seems to get glued to a particular strike, trading a little above, a little below, but always orbiting within a dollar or so of a strike price in the option chain. usually this happens on the monthly expiration fridays. so, i was a little surprised last friday, jan 31, when peter reznicek of shadow trader called-out a pin of the 500 strike on aapl. here's the chart:
aapl pinning the 500 level
so immediately i priced a trade that i call aapl butter. this is an option strategy called an iron butterfly, essentially an iron condor with the put and call strikes mushed together. in this instance i was evaluating shorting the 500 straddle while simultaneously buying the 497.5/502.5 strangle. the risk profile graph of this trade looks exactly like a butterfly but it initiates for a credit instead of a debit:
iron butterfly at aapl 500 strike
at 2:15pm, eastern, on friday, jan 31, this iron butterfly, expiring in less than 2 hours, was pricing for a credit of $1.35. i got in around 2:24pm, collecting a $1.30. since the strikes are $2.50 apart i had a net risk of $1.20.

children, be afraid, be very afraid.

now, this strategy is a bit hincky and absolutely not for newbie option traders and absolutely not for anyone lacking experience trading options in the final moments before expiration and absolutely not for anyone lacking experience with triggered orders. however, i have experienced high reliability with such trades as long as i trade them small, define the risk and follow the rules:

after getting filled on the entry, i manage this trade by immediately entering an order to buy back the "guts", the straddle of the butterfly, for 1/2 the net credit less commissions, which in this instance came out to 60cents.

  • the first rule of this strategy is: do not try to buy back the entire butterfly, you will not get filled. this is because one or both of the wing options defining the risk in the trade are/become zero-bid and the market makers will not fill that portion of a complex order (as they might with an option that has more time left on it) unless they can find a counterparty, which is not likely. one needs to leg out of these trades, buying the guts first and then selling the wings if they catch a late-day bid.
  • the second rule of this strategy is don't get too greedy by trying for overmuch time-decay. one or both of the short options might never trade down to a nickel for the tos commission-free buyback and there is a tendency of the underlying to break the pin in the last moments of the day.
  • the last rule of this strategy is to watch the trade into the close and be prepared to act if necessary.

as part of the exit strategy i create orders to sell-off the "wings", the strangle defining risk, for 10cents each, in two separate orders tiggered by the fill of the guts order. this is extremely important! after i have bought back the guts the underlying can break the pin and move to a price that pushes one or other wing in-the-money. it is gravy when one catches a wing-sale but one must have an order in place to dump that wing because this might be something that happens in such close proximity to the close that one cannot react fast-enough. one must monitor the wings into the close and if one of them is so much as 1cent in-the-money after the close one must immediately contact ones broker to tell them do-not-exercise. there is a 30 minute window of time after the close in which to do this, after which one becomes obligated to buy or short the shares, and your broker will do that regardless of your buying-power and margin-status (there are horror stories.) this is the reason one really needs to keep these trades small - contemplate what it might mean to be long or short n x 100 shares of aapl on monday morning. however, if you have the temerity to play with this particular kind of fire, as i clearly do, following the above rules will save you from the heartache of learning about this stuff the hard way.

in this particular aapl butter trade the guts order filled with 5 minutes left in the day. that was bit close but i was monitoring it closely. aapl broke its pin in the last minute of the day but did not challenge my wings.

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