Hello, It is my pleasure to come on this forum. I have been learning about Options Trading for about 18 months. However, I have been active in my leaning process for the past 10 months. Based on my friend's counsel, I am thinking of mastering the Broken Wing Butterfly (BWB) strategy. I seem to understand the basics and mechanics of the BWB trade. In addition, I have learned from from scholars like Dan Harvey, Tom Nunamaker, Andrew Falde, Ryan Simmen and several others. Nevertheless, there is something I am not clear about. May I please know how to choose the best strikes for a BWB trade if we plan to trade the SPY or SPX with a 70 to 80 DTE? I will be glad to know how to use deltas to select these strike prices. Any idea based on practical experience or back testing will be appreciated. Thanks. Col
In general the "danger zone" is the short strike of the BWB so placing the short strike's distance first is important. You'll find that round numbers of standard deviations come up frequently in Tom's videos. Since 1 SD reflects about a 68% probability this is a good starting point for strike placement. The ToS platform has good tools for seeing this.
Hi Collins. You might wish to join a trial subscription to the Road Trip Trade Service so that you can use our Entry Tool. By watching our videos and experimenting with the tool you should get a feel for the strike placement you desire. Remember that the trader's edge with butterflies comes from skillful positioning and management, not from the intrinsic probability of the trade. For example, a Monte Carlo simulation of a traditional (balanced) butterfly with the short strike placed ATM has an expectancy of 50% or less (i.e., a coin toss).
Just to clarify for myself You are saying that the the strikes should be within that 1SD or less range and not that any of the strikes should be placed at 1SD Is that correct ?
Hi status1. Placement of the short strike will depend on whether your butter leans bearish, as in the RTT, or is placed ATM (traditional or classic ATM butterfly). For the RTT butters, using the Entry Tool available to subscribers, I place the short strike 3.2% to 3.6% OTM which usually corresponds to a short strike delta of 26 to 29. As you know, the strike delta corresponds approximately to its probability of finishing ITM. So, a short strike with a delta of 30 has about a 30% chance of finishing ITM, which is in the neighborhood of 1 SD OTM.
Thanks for the clarification For some reason I thought that 1SD is the same as the 1 sigma (if that is the right name for it ) It's in TOS on the price slice and it's the line where the background color changes shades so that would be the 68.27% probability range so for -1 sigma I am getting 2169 in SPX for the March expiration which is close to 21 delta which seems a little bit too far OTM So if you are saying that 1 SD is about 30 delta than that makes more sense since that is the area where I have my short strikes
Hi again. Actually, 1 SD is equivalent to 1 sigma. As you noted, the strike deltas do not always line up with the TOS probability shaded areas. As I mentioned above, I usually pick my short strikes by percentage OTM (3.2% to 3.6%). This range gives me the optimal choice for my RTT. However, as you know, there are several different butterfly strategies and setups.
Thanks for clarifying Yes I noticed that it does not line up and it seems like in the past it used to line up with about 10 delta now it's closer to 20 Is that because the IV is so low or there is no relation to IV ? That's why I started questioning it before I even checked where the 1 SD is at the moment thinking that it was still at 10 delta
TOS uses the volatility of the index (SPX in this case) for its 68% calculation and area shading in the risk graph. However, each cycle has a different IV which may be quite different from the index volatility. Go to the Trade tab, type in SPX, and note the various cycles which appear with regard to their DTE and volatilities.
Yes I figured it had something to do with that The 8 day expiration starts out with 1 SD near 11 delta and than it moves gradually closer so even by feb expiration which is only 32 days away it's already at 18 delta than by march and beyond it seems to level out into the low 20 delta
It seems to me that if you are using the rule of thumb that the Black-Scholes Delta = Probability of ending ITM, and you are looking to place your short strike 1-sigma OTM, then you should look to sell the 16-delta put. What am I missing?
you should check that math again. https://mathbits.com/MathBits/TISection/Statistics2/normaldistribution.htm
A strike with a delta of 30 has an approximate probability of finishing ITM of 30%, but will usually be above the lower limit of the 1 SD range (in the "neighborhood", but not exact). The actual relationship of the 30 delta strike to the lower range will be somewhat variable according to cycle (DTE). Sorry for any confusion. I avoid this variability by choosing a short strike for the RTT at 3.2% to 3.6% below the money.
A strike with a delta of 30 has an approximate probability of finishing ITM of 30%, but will usually be above the lower limit of the 1 SD range (in the "neighborhood", but not exact). The actual relationship of the 30 delta strike to the lower range will be somewhat variable according to cycle (DTE). Sorry for any confusion. I avoid this variability by choosing a short strike for the RTT at 3.2% to 3.6% below the money.
I just wanted to clarify something else So is this a new or more up to date setup ? I just watched the webinar presentation from Sep 15 2016 where it says that the upper long is placed within 5 points of the current market price and than place the short strike based on that which places the short strikes higher than the percentage mentioned So does that setup from the webinar mo longer used anymore ? Was this change done to get a more optimal setup or was it to get a little more protection on the downside because of how far and fast the market moved up ?
Hi status1. We have been discussing all our latest nuances for the RTT in our weekly videos, including the DS/CS Combo trade. Please review for details.
You're right. I was forced to dig out old prob/stats material I hadn't looked at in decades. Here are some numbers taken from ToS and a Normal Distribution calculator: SPX: 2274.64 31Mar17: 74 DTE, 14.32% IV 1SD (per ToS): 2154 (actually 120.64) (apparent volatility: 11.7%) Delta at 2155 strike: -0.20 Delta at 2150 strike: -0.19 Delta at 2200 strike: -0.28 CDF(2274.64, 120.64, 2155): 0.16 CDF(2274.64, 120.64, 2150): 0.15 Sorry for the raw number dump. The conclusions are obvious though: 1SD is considerably farther away from SPX than the RTT guidelines. Actual deltas from the option chain are close to the calculated CDF values. Current RTT guideline for short placement is about 1/2 SD. It was an educational exercise, thanks!