Apple AAPL Calendar spread vs. Butterfly spread - what happens too close to expiration. Two of the options trader's key strategy tools are Calendar spreads and Butterfly spreads. Under most circumstances, these spreads are entered anywhere from 25 to 35 days prior to expiration. Enter earlier than 35 about and you take the risk of the underlying price moving too much without gaining Theta - which is where the profits come from.
Enter too late and you'll end up with a very narrow position with a higher risk of price movement loss. We decided to test the limits of these two strategies by placing trades closer to the expiration than the 'normal' range.
Trading only 17 days before expiration, we entered a Calendar and Butterfly spread at the same time to watch and compare these 2 strategies. Sell 1 Contract AAPL August Expiration Put Buy 1 Contract Everything September Expiration Put Spread Price: There is no maintenance requirement on a Calendar spread; the maximum loss is the amount you pay. AAPL Calendar - click to enlarge. Buy 1 Contract AAPL August Expiration Put Sell 2 Contracts AAPL August Expiration Put Buy 1 Contract AAPL August Expiration Put Spread Price: There is no maintenance requirement on a Butterfly spread, the maximum options is the amount you pay.
Trading Butterfly - click to enlarge. After 3 Trade Days A few days into options trade and interesting things are happening. Before we dive into the analysis, please look at the Trade Monitor screen shot below. We expanded the "Positions Details" section so you can see relevant details.
AAPL Calendar vs AAPL Butterfly Trade comparison about to enlarge. Note that the Break-even point on the Calendar: Up 1 point on our Short About.
Rising IV is good for Calendar spreads. In this case our Short Strike decreased in value as anticipated with the Time Decay Thetaand our Long Strike increased in value with the rising IV.
The result of both changes is a healthy 7. So naturally, our Short Everything which is closer to expiration will get cheaper and cheaper the closer we get to expiration where as our Long Strike will not drop in value as fast because of the options time until expiration. Price Movement was OK, but too everything given that we have only been in the trade for 3 days and there wasn't enough Time Decay Theta to compensate.
Rising IV is Fair to Bad for Butterfly spreads. With a Butterfly, we want the 2 Short Strikes in the middle to get cheaper to buy back. These positions are getting further Out of the Money, yet the price keeps going UP because of the increased IV!
With Butterfly spreads, we want to be Delta Neutral, meaning that we want the net Delta to be as close to zero as possible. In this case the Short Delta is too small to make a meaningful difference to our position.
The small loss we are showing is due primarily to the IV increase. If the net Delta was positive, we would say that our position is "Long Delta". We are Short Delta, but not enough to make a difference in the profitability. The Butterfly is now past the breakeven point and we will remove this trade now. The Calendar spread is still within the breakeven point, and the position is still showing a profit, so we will keep it open in the Paper Trade.
Before we dive into the analysis, please look at the Trade Monitor screen shot below - you may need to click on the image to enlarge it. This 'small' price movement put our positions into 'trouble' because we entered these spreads too close to expiration.
If we entered the positions during the correct time period, the breakeven points would be about out which gives these positions more breathing room as the everything price oscillates up and down.
The Price Movement was bad because of the late entry which resulted in a small range of profit. Don't enter Calendar and Butterfly spreads with less than 25 days remaining before expiration.
After 6 Trade Days AAPL continues to rise and we are forced to remove the Calendar spread. The price of AAPL moved above our breakeven point ofso we are going to remove this trade. If this was a live trade, we would have removed it earlier and the loss would have been minimal. In options, this trading trade exercise displayed four key trading lessons for Calendar and Butterfly spreads:. As the Calendar example above showed, once the underlying went past the break-even point, which was our exit point, the losses grew very quickly.
I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not trading compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Long Ideas Short Ideas Cramer's Picks IPOs Quick Picks Sectors Editor's Picks. Timing Is Everything In Options Trading Sep. These trades have expired.
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