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Butterfly adjustment thought process

Discussion in 'Options' started by Aditya, May 2, 2016.

  1. Aditya

    Aditya Well-Known Member

    Hi everyone - a newbie trying to figure out how people weigh in the pros/cons of different adjustments for trades.
    Let's say we have a BWB with risk on the downside and minimal on the upside (similar to RTT but possibly other trades exist). How does one decide if it's good to flatten out the T+0 line when the market goes south suddenly by rolling or buying a hedge ( rolling probably incurs slippage vs the hedge which will be very pricey)? How do people weigh in the pros/cons of different approaches for trade adjustments to design a strategy?
  2. Paul Demers

    Paul Demers Well-Known Member

    I am going to give you the cop-out answer "it depends". While having a plan in place for a downside adjustment to your trade I feel that there has to be exceptions to the rules. You have to ask yourself why is the market going down. Is it because it is overbought and is just consolidating or have we just had a Lehman moment. While buying a put to hedge the downside might seem expensive you will be grateful that you did that if the SPX is down another 100 points.
  3. DGH

    DGH Administrator

    Agree with Paul 100%. A "cut and roll" approach can work well in a moderate decline, but in a fast downward spiral it does little to hedge off the ever-increasing deltas and gamma. Also, depending on your account structure, there may be margin considerations if the trader begins a "condorization" process. As for martingaling the roll to pay for the debit...don't go there.
  4. Aditya

    Aditya Well-Known Member

    Thanks for your responses.
    What does martingaling the roll mean? I'm not familiar with that term.
  5. DGH

    DGH Administrator

    Hi Aditya. A martingale (the gambling term, not the sailing or equestrian terms) refers to the doubling down process. Blackjack and poker players often use this, particularly after a certain number of consecutive wins or with certain dealt hands. Some traders like to martingale their credit spreads, which would mean selling more spreads than were purchased during a cut and roll maneuver (to move the short strike farther OTM) in order to partially pay for the cost of the roll. This is a very dangerous technique, in my opinion. I used to do this maneuver when I first started trading, but got badly burned a few times.
  6. Aditya

    Aditya Well-Known Member

    Thanks for the info. I'll definitely try and avoid it.
  7. AKJ

    AKJ Well-Known Member

    A small nuance I wanted to add to the discussion: martingale adjustment strategies can lead to larger losses on both the upside and downside, but the risks are particularly acute if you apply this as a downside adjustment. Markets tend to exhibit panic-selling behavior than can lead to very fast and large selloffs, but this type of sharp move tends not to happen on the upside (and when it does, it usually is immediately following a large move to the downside).

    As an example, John Locke's Bearish Butterfly strategy implements the upside martingale adjustment quite effectively.
  8. DGH

    DGH Administrator

    Agreed, Andrew John. I have been burned a few times on the upside with a martingale when I was trading condors and weirdors, but this is less common and definitely less painful. The RTT does not employ any calls, of course, so it would only lose on an upside rally if the trader failed to make a timely Reverse Harvey maneuver.
  9. Capt Hobbes

    Capt Hobbes Well-Known Member

    However, a new BB trader reading this should backtrade expirations like March'14 and November'14, to see how 3% daily upside "crashes" in RUT do sometimes happen following an up move, and how they throw a fully martingaled position way past the planned max loss.
  10. Aditya

    Aditya Well-Known Member

    Thanks for all your responses.

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