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Yodi's Butterfly Plays
Courtesy of Yodi
The principal in general is like this. To cover your behind, you buy two further out call and put options. Say 2018 or 2019, either in the money (ITM) or at the money (ATM). Against these two leaps, you can sell current or next month's calls and puts.
This is somewhat like a calendar spread. Now why does Phil start with a (Leap) BCS and a BPS? Simply to make the initial cash outlay cheaper.
Let's look at a typical example with MSFT:
I buy the Jan 2019 $60 call with a delta of 0.53 and buy a Jan 2019 $60 put with a delta of -0.46.
Now these two bought positions act like a seesaw against each other. If the stock goes up, the value of the put goes down and the value of the call goes up. If the stock goes down, the put goes up and the call goes down.
Against the above position, I now sell a Jan 2017 $62.5 call with a delta of 0.31 and I sell a 2017 $57.5 put with a delta of -0.27. Please note the deltas of the leap options in this case are chosen higher than the deltas of the Jan 2017 options.
In theory, if MSFT stock goes up, my deltas on the Leap options will also change — the delta on the call will increase and the delta on the put will decrease. In practice, the deltas of Leap options react slower then the deltas of the short term options (Jan 2017 options in the MSFT example). The nearer we are to the expiration date, the faster the delta increases or decreases.
As long as MSFT stays between $57.5 and $62.5 on the expiration date in Jan 2017, I will pocket both of the credits I received when I sold the two 2017 options.
Selling additional Leap puts out of the money (OTM) would act as a seesaw as well, while reducing the cost of the cash outlay when setting up the initial Leap position.
The basic idea here is to reduce the cost of margin and cover yourself with the leap spreads. If you simply sold a Jan. 2017 strangle, there would be much higher margin and no cover from your leaps.
There are obviously many more ways to kill a cat. But I believe my approach offers a combination of benefits in terms of margin and risk.
[There are many kinds of butterflies! Pictures via Pixabay.]
