The whole point behind doing butterflies is to make consistent income from the theta decay time decay or moving and a directional trade.
I’ll show you here with a Fiverr trade.
It’s a little bit of a cheaper stock price.
A butterfly trade is you’re selling a ton at the money or close to the money.
Now in this case, I went a little out of the money so it’s a little bit more of a directional butterfly.
Business makes money from selling a product
So when you sell something, that’s where you’re making your money or income.
Then what you do is you kind of protect one side then you protect the other and that’s how it kind of works.
So let’s set this up from the ground up.
Let’s say we go ahead and put one on BYND.
So what you’re doing with a butterfly spread is let’s say I want to sell the time premium here at this 132.
Why would I do that?
Well this loses the most time premium. If I go to the thetas, look the ones that are closest at the money lose the most. Whereas, if you go out of the money, they don’t lose as much.
So you want to sell the most at the money. That’s the way the butterfly spread works.
Not saying you always want to sell out the money, I’m saying in a butterfly spread, it’s nice when you sell out the money because you lose the most time premium.
It means the buyer loses the most time premium, in your case you make that.
So if we go sell a single in 133.
I will do two of these: one put and one call.
I have a basic trade setup: I’ve sold two spreads.
Here’s the problem with this, I’ve got pretty much risk all the way down to zero — unlimited risk on the downside.
What’s the cool part behind it?
Well my theta decay here, which basically means the amount of premium I make every day for holding onto this trade is 35.
So here’s how this profit picture works.
This is the stock price.
So it moves to 90 or it stays at 130 because current stock price is 132. So if it wiggles around and it goes up to 170, what is it going to be?
Then this is my zero line.
This is my profit or my loss
So as this wiggles let’s say it goes to 150, I just match it up based on the white line on where is it at the time.
That’s either a profit or loss.
Here’s the beauty behind it — the white line is today green line is that expiration.
Take a look at what happens when I move this hypothetical time frame forward.
That white line keeps growing and you can see my profit and loss also starts growing by the number of theta.
I get 36 dollars added to the current profit and loss.
So again a few days into it you can see you capture a lot of time premium and then you can get out of it early.
What you can do there is take this and actually start widening it and flattening up the top.
Let’s deal with the issue that we have.
This is the baseline, we’re making a boatload of money from the theta or the time premium.
Why?
Because when you buy car insurance, the company that sells you the car insurance just pockets your money time and time again.
That’s what we’re doing, we’re selling insurance here.
So when you send your 200 check every month to your car insurance company, what do they do with it? They pocket it. Money comes out of your wallet goes into their wallet.
So that’s the same thing here, you sell one of the calls and you sell one of the puts and you’re making money.
The problem is, if somebody gets in an accident or you get a stock problem here, you’re in trouble.
So what do I do?
Well I’ll go further out, let’s say at the 125 on the put side. I’ll buy a single and I’ve got some protection now.
Then I will do the same thing over here at let’s say the 140 and I’ll buy a single here and I’ll get some protection.
What do I have?
I’ve got this butterfly trade set up now, it’s not perfect right now.
You’re gonna still have a theta, not as big of a theta but a positive one.
That’s the power behind butterflies is that you get the fastest theta.
So let me buy it as a single butterfly spread which will actually make the trade better.
Then what you’re doing is sell an iron condor and that way you can see it exactly like this.
So I’ll sell the 133s then I’ll buy the 140s and 126s.
Now I’ve got kind of a single trade butterfly rather than splitting it up all in the contracts.
It’s the exact same trade there without being down because I have to pay a bid ask spread on every single contract. If I do it as one trade, it makes more sense.
Now I’ve got a theta of 1.82 and I’m only using 118 dollars capital.
So if you multiply this times, let’s say 20 contracts, you’re using about 2,360 of capital but you got a theta of 36.
Every day you’re making about 36 bucks from those short positions and you’re still protected.
With time, that theta grows. That continues to ramp up and that white line keeps getting closer. The stock price isn’t going to stand still so you might be over here.
That’s fine. You’re still capturing quite a big premium.
The point being is you’re capturing this time value because the most time premium is right at the money. That’s the ones you’re selling.
So if you look at this trade, the ones I’m selling are right here.
That is kind of right at the current stock price, which is 133 dollars.
This can be really powerful for these non-directional trades.
Now let’s say you want to go directional, just as a little bonus, you could go ahead and lift one of these legs.
I can be a little more bullish or you could flip it to the other way and be a little more bearish.
You can do these based on your own personal taste.
