The $SPX Broken Wing Butterfly Weekly Options Strategy: Q&A

so lots of traders like the idea of trading options buying cheap calls on stocks they're bullish on and cheap puts on stocks they're bearish on trying to make cheap quick profits but for lots of reasons these trades often turn out badly because to buy an option cheaply means that it's got to be pretty far from the current price of the market so the market has to move pretty far for that option to expire with any value at all well that can be a frustrating experience for traders in fact traders don't really realize this but 75% of all options expire worthless because the market never gets down to the level of their put or up to the level of their call in fact the market can go exactly the direction the trader predicted and they still lose money on their trade and that's because the market ran out of time to give their option value if the option had expired a few days later they might have made money instead the trader has to sit and watch the market do exactly what he thought it would do yet he lost his entire investment in that option because it expired too soon well what if there was a way to turn this whole situation on its head and instead put together a combination of options that guarantees a profit if the market rallies and at the same time is designed such that if the market sells off in a reasonable fashion a possibility for a really spectacular return exists well the good news is that there actually is a 10-day trade that does just that and it really is not that difficult to learn or understand so if you're interested in a weekly option strategy that's guaranteed to win if the market rallies wins if the market sells off mildly and has the potential for spectacular gain if the market gradually sells off during the course of the trade that I'm sure you're going to be interested in this videos to stick around [Music] hi I'm Seth Freiburg and I'm the head trader of SMB capitals options trading desk here in Manhattan SMB capital is a proprietary trading firm located in midtown Manhattan and we provide capital for options and equity traders from all over the world trading both remotely and in our offices here in New York City you'll want to click our subscribe button right now so that you don't miss any of our free trading videos produced for the trading and investment community now in this video we're going to be reviewing a weekly option strategy using a formation known as the broken wing butterfly and we're gonna be setting it up so that it is guaranteed to win if the market stays still or rallies over the 10-day life of the trade that's the easy part which is quite rewarding on its own but what I think you're gonna find particularly interesting is what can happen to the trade if the market actually sells off gradually during the course of the trade that's where the lottery ticket size returns can happen but you've got to set the trade up right in the first place to give you this combination of potential outcomes I'll be showing you just how to do that exactly in a few moments while we're talking about option strategies if you'd like to learn 3 more real-world option strategies that our traders use including the surprisingly simple and powerful strategy that some of the greatest investors in the world like Warren Buffett use all the time plus an options trading strategy that has a statistical 80 percent probability of profit month in and month out plus an option strategy that you can employ with a stock that you like where you'll make your target profit whether the stock goes up goes nowhere or even goes down a small percentage then you should check out the free options class that we're currently running just go ahead and click the link that should be appearing right now at the top right corner of your screen that will open the free registration page in a new window so don't worry you won't lose this video you can also visit options class.com to register for this free intensive workshop now it's an extremely rare opportunity for retail traders and investors to learn directly from Wall Street traders but that's exactly what you'll be getting through this free online workshop so click the link to sign up now and don't miss it alright guys so we're gonna be talking about an option strategy today called the broken wing butterfly and I want to kind of break some things down for you first so that you understand how the broken wing butterfly works everybody in the room knows what a call option is and a put option just to review if you buy a call option it gives you the right to own 100 shares of a stock at a certain price called the strike price as long as you exercise that option at or before the expiration date of that option a put option on the other hand gives you the right to sell shares you own at a certain price at or before that option expires so for example if Google is trading at 1200 and you own the Google 1250 call and Google goes to 1350 on expiration day then you can go ahead and cash in any time actually before expiration day you can go ahead and cache those options in and buy Google at 1250 even though it's trading for 1350 and therefore make $100 per share and you would be cashing that in for 100 shares so that's the way a call option work a put option you know would be just the opposite as to selling them now what a lot of people don't realize is that there's such a thing as index options now can you buy an index can you buy the Dow Jones Industrial Average you can't buy it right you can't buy one share of it you can't buy a thousand shares of it you can't buy an index because an index is basically a basket of stocks right but what you can do in the options market is buy a contract which pays you if the index in the case of calls exceeds a certain strike price or in the case of puts drops below that strike price and what you're paid is $100 per point so if you own one S&P 500 option which known as the SPX options if you own let's say the SPX is trading at 3000 and suppose that you own the 3100 SPX put that expires in on September 1st ok and suppose the SPX goes to 3,200 or let's make it a little mathematically easier 13150 by by September first what would that option be worth on September 1st it's a 3100 strike yet the SP is trading at 30 150 how much cash would you get for owning that call anybody that's correct 5000 you would you would multiply 250 points between the strike price and where the markets trading times the 100 times 100 for every point so 50 times 100 is 5000 that's how a call works now let's do the same example with the SP trading at trading at 2900 okay so in that example you own the the I'm sorry let's take an example of your owning the 2900 foot and the S&P drops to 2800 okay what would that be worth on expiration day 10,000 dollars that's right okay now suppose it drops to 2901 what's it worth on expiration day zero very important worth zero how about 2900 zero you're not gonna it did get below 2,900 you know get anything suppose it rallies to 3,500 what's it worth zero okay you just pass the test so that is the way index options work they are a cash it's very very similar to an insurance policy it's insuring you a call insuring you against the market going up a put is insurance you insuring you against the market going down now so what are we going to do with this information and what we're gonna do with this information is put together an option strategy called a broken wing butterfly now one thing I haven't reviewed so far is the fact that in the options market you are allowed to combine short and long options together in what are called option strategies options structures is another term for it and you do this through submitting a complex order what's called a complex order meaning you're not buying ten of a particular option you're buying ten of a group of options and in many many cases they are a group of short and long options combined so what you see up on the screen right here is a broken-winged butterfly and this is ten days from expiration on this particular date now the this is an index I'm not really going to identify the index because I want you to understand the principles and not focus on when this occurred or anything else this will be true in the past present in the future now so this particular index is trading at seventeen twenty four you will see that what we're doing is we're buying ten of the seventeen hundred foots we're selling 20 of the 1690s and we're buying ten of the 1670s all right we're doing that all at once and I can show you you were anybody interested later I can show you how to actually put in a complex order into broker we use here in our in our prop firm and it's easily done and it's easily filled because they have at the CBOE what they call a complex order book which is all the places where all the bids and asks for complex orders we'll put it all right so they'll see this order coming in and somebody's gonna fill it now so let's break down why the heck did I do this why the heck did I go in and buy ten of the 1700 sell twenty the 1690s and buy ten of the 1670s at the same time why did I do that and the reason I did that was because it creates a scenario scenarios that I find favorable now what are those scenarios well the first thing you need to know is let's take a look at that that top put that six that's 1700 foot right that's gonna cost if you saw the prices on that previous options chain that's gonna cost us five dollars and fifty five cents times 100 for each option so that's actually five hundred fifty five dollars but we're buying ten of them so the math is ten options times 100 because every individual option you multiply the price by a hundred times the quoted price so it's 555 times ten times 100 so we had to pay to buy those ten we had to actually had to pay five thousand five hundred fifty dollars now but we then went down and sold 20 of those 1690s we sold 20 of those well those are trading for 380 so it was 380 times 100 times 20 and that comes out to 76 hundred dollars then we went down and bought the long 1670 puts basically for protection and those we purchased for a dollar 90 times 10 times 100 so that comes out to if you add all of it up you actually receive cash for this transaction because the 20 show kourt's the value of those were a little bit greater than the that they turned out to be a little bit greater than the purchases of the of the 1700 and 1670 puts so we got in 150 bucks into our account you will see your account go up by under $50 as soon as this transaction occurs it's not that your account will go up your cash in your account will go up okay and the broker for reasons that are too complicated to explain right today always going to require you to have nine thousand eight hundred fifty dollars in your account in order to do this transactions by the way you could do this as a one lot by one cell to buy one and the whole every number just divided by ten so you need nine hundred eighty five dollars so you don't necessarily have to have ten thousand dollars in your account to do this what is the deal and what the deal is is that I want you to think through what's going to happen if this index goes up let's say it goes up to seventeen fifty by expiration day did I make money on the transaction did I lose money did I break even what happens who knows three strikes again seventeen hundred sixteen ninety sixteen seventy okay I got it in one hundred fifty dollars in cash ten days goes by the index is rallied to 1750 what has happened to my piano what's my P&L be options have expired trades over somebody calculate my piano was thirty why was 80 plus thirty the law puts a worthless the shorts we're at 1690s at seventeen you know write x to the 1 2000 but times 100 so I'd be minus 12 here's a better way to do it I want you to give me the value of each of the options on expiration day if that's at 1750 what's the value of the 1700 what's the value of the 1690 the strike the strike just that option does it have any value no it is the strike somebody who owns it just think about owning it even though you've sold it imagine if you own it what are you going to get for that 60 90 put anybody 0 think about it it's trading 1750 here's an option that only pays off if it's dropped to 1690 okay how about this 1670 what's that worth zero so it's a whole bucket of nothing right all options expire worthless we just prove that right so what was your P&L on the trade $150 got 150 bucks and what you did was you basically put together a transaction that had no value to anybody ten days later but they gave you 150 bucks for it that's what happened that's the reality of what happened okay just like you buy a car insurance policy and you don't get into an accident did they give you your money back they give you a premium back now they keep it right I used to run an insurance company so I know about this and that's what happens you you keep it so that you you get to keep the 150 so here's what's interesting suppose the stock drops to 1700 the index drops to 1700 let's look at it so now it dropped okay it dropped but it dropped and stopped at 1700 what happens everything expires worthless again why even the 1700 is worthless because it didn't get below 1700 we've got the 1699 now it would have a little bit of value but it didn't so think about all the scenarios where you get to pocket the 150 the market rallies a lot the market rallies a little the market doesn't move the market drops 24 points you make your 150 in every one of those scenarios now here is what's interesting if the market drops below the 1700 put but doesn't make it to the 1690 I start thinking about what would happen and I'm gonna show you what would happen this example that I gave you which is a real example the index closed at 1690 180 now is this fluky yes does it never happen no it doesn't never happen it happens every once in a while okay I want you to see what happens when that happens so in this actual historical example the index dropped to 1690 180 all right so now let's see what happens the 1690 put let's do the easy part the 1690 put expires worthless right because it's 60 90 180 the 1670 put expires worthless right 1670 but what happens that's 1700 put it's now in the money what's called in the money by $8.20 meaning it now has value and that value is calculated by the strike price minus the market price of the index when it when the options expired that day so so 1700 -16 90 180 is 8 that's how much you get paid off but not $8.20 you get $8.20 times 100 times the 10 options that we owned so that is $8,200 so I want you think about what happened you got a 150 bucks up front then you got eighty two hundred dollars basically because of exclusively because of the value of that 1700 foot the other ones expired worthless and therefore you made eight thousand three hundred fifty dollars on this trade compared to the ninety eight fifty that you had to put up to do the trade in the first place because of the capital that's required so what's our takeaway from this lesson lots of takeaways but one important takeaway is there's such a thing called index options which pays you off in cash instead of pays you off in shares another important takeaway is you can combine options short and long in two structures that allow you to make money in different scenarios this specific structure we built in this case the broken wing butterfly has a unique feature to it when it's used in this way and that is you can set it up so that you get a credit for it and the the technical reasons we can get into another day but you can just see from the flat out pricing that you ended up with a credit for it and basically the reason you got the credit was you just sold this 20 of those 16 90 puts right and those have less value than the 1700s because the seventeen hundred's are even closer to the market but nonetheless you sell in twice as many and then the one you bought at the bottom was not tens points away but 20 points away oftentimes when you do that you're gonna end up with a credit because the one just sold have a larger total value because you're selling twice as many than the cost of the other two doesn't always work out that way but it frequently works out that way so when you put this structure together what it does is it creates this really interesting and unique opportunity which is you make money in four of the five scenarios any trade only five things can happen goes up a lot goes up a little doesn't move it all goes down a little good at it goes down a lot that's it there's the only five scenarios right this one makes you money in four of those five then there's like a fifth scenario there's five a and there's 5b 5b is the market goes down so far you start losing money on the transaction and that would happen because the 1690s that you're short start getting worse and worse for you because you now you've sold 20 of those your short those and the markets going down so that's going against those options but that's five B that's the bad one five a five a is the great one that's where the you don't trigger the short options at all you simply make money on the top most long option and then you cash in like you did in this case incidentally if the market went to 1688 and those short options started to hurt you a little bit you would still make money on the transaction if you do the math you would still make money on the transaction you just wouldn't make as much because you're giving back some of the money you made on that 1700 foot by having to pay off the owner of a 1690 puts your 20 puts and you you owe him money and you got to net that out and the net of those gives you your example so your gives you your profit so yes why did we use different distances on the strike price that's a great question and that's why it is called a broken wing butterfly as opposed to a regular butterfly you know just from the language what would you guess a regular butterfly is a normal their equal distance between the lungs in this between the the middle short two times and the one times on either side of it are equidistant we do it because there was a cheaper option yeah in other words right the one you buy the 1670 is cheap enough that the whole transaction becomes a credit okay let's go a little further what if you bought the 1660 you Neve get that's correct you get a larger credit very good and suppose you put it closer and you made them equi distant probably wouldn't be accredited you have less risk on the downside very good excellent that's right it it it's never a credit I can't think of a case where that would be a credit right it just works out that way so so that's a broken wing butterfly that's a that's actually not a beginner strategy you just learned more like an intermediate level strategy but because we broke it down for you I think it was understandable and hopefully you learned something today now don't go out and do a ten lot please I know what happens to people they get excited this is cool and they forget about the risk and there's a reason your brokers you know cap requiring 9815 capital because that technically is the worst that could happen on this trade and it can't happen now you got to protect against it and you got to have a stop on the trade like you have any other trade but that's a possibility also but in the most cases in the four out of the five scenarios you're going to make your hundred fifty bucks so in ten days if you do the math on that that's a little greater than one and a half percent over ten days yeah so you do this every week well you could do it technically that's 52 times a year right a ten day trade you know you're gonna have some losses in there and you have to have a stop on it we could talk about that another day will be an appropriate stop on a trade like this but all you need is one of these eighty percent returners and it's going to be very helpful for your return that you so any questions we're making money in four out of five four out of five foot you know 1/2 595 be scenarios yeah but it's there a scenario where you're not like selling these options or exiting these options all at the same time yes you can just as there's a complex order book for someone to sell you this combination to actually technically buying it from you but there's a complex order you could take this complex order flip it and sell it a minute later okay so you don't have to let them expire that does answer question but I think my main question is like keeping on two out of the three options if the market makes do you know what I mean you're saying mid trade doing something with some of the options you absolutely can do that I did that today for example I had I said they have on it's a much longer term trade than this but I have on a broken wing butterfly right now on our trading desk today I just took the top ops I took twice the top option and the middle short option and I closed those I had a 25 lot on and I basically sold to each of the top option the top long option and the middle two of those middle short options that I entered what they call credit spread to do that and I closed that because I had a reason to do that I had some technical options reasons that I felt it would be advantageous of me to do that so yes you can you can do that you can close portions there's that you own those options so you can do what you want with them you don't have to keep it in that complex order formation you can break it up if you want to now your margin may change you may put yourself into a much more dangerous position by something like that in which case your broker is gonna margin the hell out of you for doing that but you absolutely can do that as long as you have enough capital in their account yes the possible just like removed the bottom six 1670 long and then just in the scenario where the market does so long cover the short puts a 1689 and also so belongs well first of all these are their only five point strikes so you couldn't do that in this in the case of this index but it's kind of in theory you could cover them you're saying why buy them if you're not if you may not need them why buy the production one here's why first of all your broker is going to demand a massive amount of capital from you to do that which should tell you something it means you're taking a massive amount of risk because what if the market gaps overnight from 1724 to 1650 now you're short the 1690s all the way down to 1650 you do have the 1700s helping you but you only got ten of those and you've got twenty of the shorts so you would say well go in and cover the 1690s right it's a little late for that because they have now blown up so for you to buy those back you're gonna essentially lock in this a gigantic loss so it's like the game's over already the problem with doing it the way you're suggesting is the the value of the options that will either literally close the 1690 or 1689 will be massive and now you got it 150 bucks and you just paid out some thousands and thousands of dollars to buy that 1689 because the markets trading at 1650 I do not know any trader who would do that trade that you just said because of that reason I didn't know you couldn't come well most options that most people trade stop trading an index option stop trading at 4:15 p.m. now there are es options where should the options on the e-mini s-- which are what people quote when they're talking about the futures but we do stay all not up all night I mean you know and you couldn't put you don't want to put an automatic order in in the market for the middle of the night think about what well all of you were around on November or whatever it was 2016 when they had the US election the futures dropped I I don't know where the I think the SP was down over a hundred as it was obvious Trump was gonna win by the next day the market had rallied and then didn't stop rallying for two months okay so suppose you had put in an order for an es option that if the market dropped 50 points below you put and you bought that option in the middle of the night because your broker executed your conditional order right next morning you're not a happy camper because the market rallied so you ended up buying it in the middle of the night because you were asleep you didn't understand that the market was bouncing you got a big problem and so it doesn't really work so you got to buy the protection upfront it's kind of like saying here's a good example why do I have to buy fire insurance just as soon as the house starts like you know just like the living rooms on fire right nothing else can I go out and buy fire insurance all right no you can't because they're gonna ask you in your application that you're filling up very quickly is your building burning right now okay and if the answer is yes they're real not gonna buy you sell you the insurance so it's not that bad because you can buy it actually you could buy the insurance on a burning building but it would probably be 90% cost 90% of the value of the building which would kind of make it worth it so that is why it's just think see I'm an insurance guy so I but it's a really really good analogy to options it's an excellent way to think through options options what happens to options one of big events coming up do they go up or they go down what do you think they go up why volatile increases and that means what people's well yes that's an interesting point but the people selling it realize something bigs about to happen I'm not gonna get run over here I'm gonna charge if I'm gonna get run over I'm gonna charge for it okay so they charge heavily for that what do you think happens to insurers of homes along the east coast of Florida on the beachfront when a hurricane is coming in from Africa what you think happens to the cost of the insurance number one a lot of them stop writing okay but the ones who are do write first you know as if the Hurricanes literally bearing down the they're not gonna write it but if it's coming off of Africa they might still write it because you don't know where really it's gonna go they're gonna charge you a pretty penny for that and they're not by the way just profiteering there's a real problem if that hits and they know it and they've got to get paid for it that think about that that if you want if you really get interested in options keep these analogies in mind because it's going to explain everything going on in the market options are about fear there are a fear measure right the values of them go up because of fear and they come down because of the release of fear so right before but that's why if if you if you do an earnings play with options you come in and you do a you sell the options at the money you know good let's go back to Google trading 1200 Ernie's are coming up and you sell the 1200 Google call and you sell the 1200 Google put you will receive a fortune for doing that you the cash you're gonna get is gonna be immense why because you're taking an immense risk because Google can gap 150 points overnight depending on an earnings positive or negative result so if you've sold the 1200 put and it's down at 1050 now you are what they call hurt and pop okay on the other hand suppose google has it like a matt earnings release and you got paid 200 bucks for selling both the at the money call on the at the mony put and them stock just little move like 25 30 bucks just made a lot of money so these are called earnings place they're really dangerous and they're really really profitable depending upon whether the market moves a lot or the market moves a little so anyway you know I call options three-dimensional chess stocks they can go up there go down right but with options the stock can go up and the option the call option can go down and it can happen because it's running out of time you got the 12 Google goes from 1200 1240 you got the 1250 call unfortunately its expire in five minutes so even though the stock went up and you own the call you still lost all of it you lost your entire investment in that option even though it did exactly pretty much what you thought it would do so that's why on our desk we like to sell options that are buy options because 75% of all options actually spire worthless but they don't tell you that the SIBO because they want people to buy options what is the major takeaway from this example that we've shown you today well we shown you that there is a way to combine options for a short term index options trade that can provide you with a guaranteed profit in four of the only five scenarios that can happen with a trade as we reviewed more excitingly there's a pretty spectacular outcome that can occur if the market moves down in an orderly way such that the short puts in this strategy expire worthless so it's exciting to think that you can execute a strategy that while it certainly can lose money in certain circumstances that's true of any trade it works out very well in so many different scenarios as long as you know how to put that trade together correctly in the first place just to remind you as I said earlier if you enjoyed the video and would like to learn three more real-world option strategies that our traders use including the surprisingly simple and powerful strategy that some of the greatest investors in the world like Warren Buffett use all the time plus an options trading strategy that has a statistical 80 percent probability of profit month in and month out plus an option strategy that you can employ with the stock that you like where you'll make your target profit whether the stock goes up goes nowhere or even goes down a small percentage then you should check out the free options class that we're currently running just go ahead and click the link that should be appearing now at the top right corner of your screen that will open up the free registration page in the new windows so that you don't lose this video it's an extremely rare opportunity for retail traders and investors to learn directly from Wall Street traders but that's exactly what you'll be getting through this free online workshop so click the link to sign up now and don't miss it now one more thing I'd like you to do is go ahead and click our subscribe button so you don't miss any of our trading videos produced for the trading and investing community and while you're at it add your feedback in the comment section for what videos you'd like us to produce next as well as what you found helpful from this video so from all of us at SMB trade well

Channel: SMB Capital

Views: 53,224

Rating: 4.8528061 out of 5

Keywords: stock market, day trading, smb capital, trading, investing, markets, wall street, stock trading, options trading, options income, economics, finance

Id: vU64DYL3raU

Length: 38min 8sec (2288 seconds)

Published: Wed Jul 17 2019