John, re the 4/1 R/R, since that’s a factor of the width of the butterflies, would you consider using smaller width butterflies to get a better R/R? And as an extension to that thought why does the BB use 50 point wings? Thanks.
This forum is for students of the Bearish Butterfly trading strategy to share information.
2005 – Worst Year Ever for the BB
March 30, 2016 at 10:04 am #3490
March 17, 2016 at 3:31 pm #2921
Thanks Andrew…..Its hard to understand (at least for me) how you use these unless you expand on the ideas….not sure if you’d have the time to do so, but it may benefit the community.
March 17, 2016 at 3:14 pm #2918
ATM IV, 95-100 IV Skew, Delta/Theta, Distance between Center Strike of most expensive Fly and current spot (another way to gauge where the peak of your T+0 will be without relying on a model).
The Spot, ATM IV, and 95-100 IV Skew are the important building-block data points; all the other metrics I track or that you could potentially track are derivative from these three (imho).
March 17, 2016 at 2:16 pm #2914
Thanks John for chiming in.
Andrew, You said, Rw/Ri is one of several critical metrics that you look at when planning your BB trade. Would you like to share what other critical metrics do you look at?
March 16, 2016 at 8:42 pm #2907
Yes, ideally you want a 4/1 R/R which would be $10.00 or less. I consider anything less than 3/1 R/R ($12.50) very poor market conditions for the trade. In the past would not trade an M9 (M21/BB) unless I had an extremely favorable market cycle. If your getting $13+ butterflies and the market is not over extended, the only decent options trade is a straight bull vertical.
March 16, 2016 at 6:55 pm #2905
thanks Andrew for clarification on Rw/Ri ratio. That’s excellent way of looking at it. Thanks for pointing it out.
March 16, 2016 at 11:55 am #2903
Gabor MalyParticipant@firstname.lastname@example.orgPoints: 525Rank: Freshman
To me 2005 IV environment seems to be worse than 2013. Given OV provides IV data for a very limited range in 2005 I can not show this to you on graph and back it up with data but just by looking at the T+0 lines for the different months at DTE 56 IV skew in 2005 does seem to be particularly skewed. Prices are very expensive and range is terrible. In majority of expirations you start out with violating your 1.5/1 delta theta ratio rule right from the start trading just by the guidelines. As mentioned above you need to decrease your width at least to 40 due to the price level of RUT (your 50 wide fly costed 16+ bucks in all expirations) but even then it remains to be just one hell of an ugly looking T+0 line. Going out to further or bringing in some range extension techniques is probably a good addition IF you really wanted to trade BB in an environment like 2005.
Great that you have raised these questions on 2005 I have never went that far back.
March 16, 2016 at 9:57 am #2902
Thanks for the input guys. The IV was similar in 2005 and 2014. I think the answer lies in the width and spacing of the flys as per your suggestion.
March 15, 2016 at 3:07 pm #2894
You are referring to risk/reward of the entire campaign. I am looking at risk/reward of the specific butterfly as a way to plan my campaign.
A 50-wide butterfly has max payout at expiration of 50 (full value on debit spread, credit spread expires worthless). If you pay 12.5 for that butterfly, the max P&L is 37.5. 37.5 divided by 12.5 is 3/1 ratio.
If instead you paid $10 for the 50-wide fly, then your reward/risk ratio is 4/1. If you paid $15, then your reward/risk is 7/3.
March 15, 2016 at 2:44 pm #2890
Andrew….What do you mean by targeting a 3/1 Reward/Risk ratio in a BB. As per regular BB guidelines, Max gain is 30% and max loss is also 30%, which looks like 1/1 Rw/Ri ratio to me…do you get out at 10% max loss, which would dramatically lower the probability of profit (PoP). This is mathematically expected, since any time we have a better Rw/Ri, the trade is bound to have lower PoP.
March 15, 2016 at 1:03 pm #2881
D G, correct. This is essentially what I do when I trade it. It’s based on a great deal of backtesting, but I try to target a specific Reward/Risk ratio range when I plan my trade.
If I’m targeting a 3/1 Reward/Risk ratio, then I will look to pay no more than $12.5 for a 50 point fly. If a 50 point fly is more than $12.5, then I would look to a 45 or 40 point fly that gives me a higher Reward/Risk ratio, but maybe a lower probability of profit.
I’m not suggesting that 3/1 is the right ratio (I’ve done some backtesting and have come up with a ratio that I am comfortable with) but this is one of several critical metrics that I look at when planning my trade.
March 15, 2016 at 12:33 pm #2876
One could also modify BB to adjust according to RUT level. Right now, RUT BB with 50 point wings and 20 points distance apart looks reasonable when RUT is trading between about, lets say, 700 to 1500. But when those prices are breached, it may be a good idea to adjust the BB slightly. This will also require a consideration of market IV, for example, if the market were to tank to 500 today, tightening the spreads may not be a good idea, but in 2005 it might have been.
March 15, 2016 at 8:24 am #2871
Along the same lines, I would recommend analyzing the differences in butterfly price and deltas at different Index levels. This will help illuminate the differences you’ll encounter in trading the same 50-wide butterfly placed 20 points below the money at a 600 index level versus a 1200 index level.
March 14, 2016 at 10:22 pm #2868
Rick RogersParticipant@email@example.comPoints: 360Rank: Freshman
Michael: I have not tested 2005, however Delta is related to IV and as we learn in the Rock Trade (it has a Delta entry test), we see greater position Delta with lower IV conditions. Lower IV also leads to greater Butterfly costs and therefore increased risk.
March 14, 2016 at 5:08 pm #2862
i am an options newbie so i am not sure how options react at different price levels and to an absolute versus a relative change. my background is in stocks so i am used to looking at % changes.
that said it seems like the delta values in 2005 were much higher. i do not know why this is as per my understanding of black scholes delta is not dependent on price.
it would be nice of course if we can define the rules of the bb such that it is tradeable at all prices.
March 14, 2016 at 8:49 am #2848
March 12, 2016 at 1:54 pm #2836
can somebody tell me how to include line spaces in this editor?
March 12, 2016 at 1:47 pm #2834
I looked at the % daily returns for 2005 vs 2014 and they were very similar, 2005 ranging between -2.84% and 2.40% and 2014 ranging between -3.21% and 3.11%. So relatively speaking the moves were quite similar for both years. See attached.
File is not loading, if anyone want it send me a message and I’ll email it.
I think 2005 illustrates the challenges with using a rule based system. 2005 had a lot of ups and downs that do not work for this strategy.
March 13, 2016 at 12:33 pm #2839
you are correct, the % changes seen in both years were fairly similar. The important thing is that the price level is different. 1% move on 500 is 5 points. 1% move on 1000 is 10 points. Do you think it is optimal to be trading 50 point butterflys with an add/roll structure that is 20 points apart in both markets?
March 11, 2016 at 5:27 pm #2810
RUT range 2005: 575.02-690.57 (RVX: 16.2-24.94)
RUT range 2014: 1049.3-1219.1 (RVX: 15.17-27.19)
The vol range is roughly the same but the index level is twice as high in 2014. The fact that the strategy has performed for so long is a testament to the robustness of the underlying principles. Some tweaks should be considered though to optimize in different vol environments and at different price levels.
March 11, 2016 at 4:49 pm #2805
I have doing some extensive testing on the BB and as it turns out, 2013 was not the worst year for the BB, 2005 was. It ended the year at -11.3% with a monthly draw down of -36.83% although it could have easily been much worse.
I would appreciate it if somebody else could run through these months and double check my work. I did all the backtesting in OV using the standard guidelines and 13:30 pm (half hour before market close) decision time.
Also, if anybody has any ideas of how to improve this strategy I’m eager to learn. Of course one would have to consider how changes effect the other years besides this one.
I was expecting 2005 to be like 2014 since the RUT gained 3.32% compared to 3.53% in 2014 so the results are a bit of a shock.
Note that OV only uses a dividend yield of 1.27% for the RUT as of late 2015. So during the backtesting the dividend yield was 0%. Not sure if this effects the modeling and hence the results
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