What are the characteristics of this option strategy?
Unbalanced butterfly spreads are butterflies whose two wings are deliberately uneven, either because the strikes are spaced differently on each side or because the legs carry different numbers of contracts. One common form buys 1 in the money call, sells 2 at the money calls and buys 1 out of the money call with the upper gap wider than the lower one; the put version in the worked example below uses a 1-3-2 ratio instead. Skewing the wings moves the profit peak and can turn the trade from a debit into a credit. Both the maximum profit and the maximum loss are capped as long as every short contract is covered by a long one, and the maximum loss is normally several times the maximum profit. If the short leg carries more contracts than the long legs combined, the excess contracts are naked and the loss on that side is uncapped.
Is this a bullish, bearish or neutral strategy?
The Unbalanced Butterfly Option Strategy is close to neutral, but it is not indifferent to direction. It pays most when the underlying finishes near the middle strike at expiration, and the uneven wings tilt the payoff toward one side, so the trader is expressing a view that the underlying will land in a particular range rather than simply that volatility will change.
Is this a beginner or an advanced option strategy?
The Unbalanced Butterfly Option Strategy is an advanced strategy. It requires a knowledge and understanding of options, market dynamics and risk management.
In what situation will I use this strategy?
The Unbalanced Butterfly Option Strategy is best used when you expect the underlying asset to exhibit volatility but remain within a certain range, over a certain time period. The key to success with this strategy is placing the middle strike near the level where you expect the underlying to finish, and managing the position if it drifts away from that level, since the payoff depends on where the underlying lands rather than on how much it moves.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The Unbalanced Butterfly Option Strategy has a defined maximum profit and, in the covered form used in the example below, a defined maximum loss as well. The probability of profit is usually higher than 50%, and it is paid for with a maximum loss that is normally several times the maximum profit, so the risk/reward ratio is unfavorable even though the win rate is not. Check the contract counts before assuming the loss is capped: if the short strike carries more contracts than the long strikes combined, the surplus is naked and there is no cap on that side.
How is this strategy affected by the greeks?
This strategy is affected by the following greeks: delta, gamma and vega. Delta measures the sensitivity of the option to changes in the underlying asset, while gamma measures the sensitivity of the delta to changes in the underlying asset. Vega measures the sensitivity of the option to changes in volatility.
In what volatility regime (i.e VIX level) would this strategy be optimal?
The Unbalanced Butterfly Option Strategy is best suited for markets with moderate levels of volatility, since it needs the underlying to settle near the middle strike rather than to trend away from it. A VIX level of around 20 is considered to be optimal, as it prices the wings attractively without making a move out of the profit zone likely.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
Adjusting the Unbalanced Butterfly Option Strategy when the trade goes against you can be tricky and requires knowledge and experience in options trading. The difficulty of the adjustment will depend on the market conditions, the underlying asset and the duration of the trade. It is recommended that you practice adjusting the position under simulated trading conditions before attempting to do it with real money.
Where does this strategy typically fall in the range of commissions and fees?
The Unbalanced Butterfly Option Strategy typically incurs high commission and fee costs, as it involves trading six options contracts. It is important to factor in these costs when trading this strategy, as they can eat away at any profits made from the strategy.
Is this a good option income strategy?
The Unbalanced Butterfly Option Strategy is often used as an income strategy, as it can be opened for a credit and wins across a range of outcomes. However the loss when the underlying lands in the wrong place is far larger in dollar terms than the credit collected, so it is not recommended for risk averse investors
How do I know when to exit this strategy?
The Unbalanced Butterfly Option Strategy can be difficult to exit, as it involves trading six option contracts. It is important to monitor the situation closely and adjust the strategy as required. Good exit points include when the maximum profit has been realized or when the underlying asset gets to the point where it could lead to a large loss.
How will market makers respond to this trade being opened?
Market makers will typically bid up the prices of the options when the Unbalanced Butterfly Option Strategy is opened, as they want to benefit from the spread between the bid and ask price. Therefore, it is important to factor in this cost when trading this strategy.
What is an example (with calculations) of this strategy?
Consider a stock trading at a price of $290. A trader can execute an unbalanced butterfly by selling 3 puts with a strike price of $285, and simultaneously buying one put option with a strike price of $290 and 2 put options with a strike price of $275. Three short contracts are covered by three long contracts, so the risk is defined. The investor enters this trade for a net premium of $11. The profit zone at expiration starts at about $282.44. The maximum profit of $511 occurs only if the stock closes exactly at $285. If the stock closes at or above $290 all the puts expire worthless and the profit is just the $11 net premium, and at $280 the position is already down about $489. Below $275 the payoff flattens out, because the two long $275 puts take over from the third short $285 put, and the loss is capped at about $1,489.
MarketXLS
MarketXLS is a powerful Excel-based financial and options trading platform, designed to give traders in-depth analysis, greater insight and more control over their investments. MarketXLS provides real-time quotes and data, interactive charts, customizable spreadsheets, specialized trading tools, and extensive back-testing capabilities. In addition, MarketXLS has an extensive library of options trading strategies, including the Unbalanced Butterfly Option Strategy. With MarketXLS, traders have the tools they need to develop and manage their strategies more effectively and measure their performance accurately.
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Relevant blogs that you can read to learn more about the topic