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In today’s video we’ll how to both trade understand butterfly spreads on the ThinkorSwim platform.
The term butterfly spread refers to an options strategy that combines bull and bear spreads with a fixed risk and capped profit. These spreads are intended as a market-neutral strategy and pay off the most if the underlying asset does not move prior to option expiration.
For it to work out you basically pick a price, usually right at the money, where you think the stock will be right at expiration. The bulk of the profit potential on the trade really wont come in until the day of expiration and even towards the last couple hours or even minutes of that trading day. So like I said, kind of like a lottery ticket. Low risk, high reward if your right. Although very unlikely you’ll be right.
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0:00
Hey everyone, welcome back to the Thinkorsome tutorial series. In today's video, we're going
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to go over how to both trade and understand butterfly spreads on the Thinkorsome platform
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Now, to start off with, let's go over how butterfly spreads actually work. And for the
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most part, they're generally considered a more neutral strategy, and they're going to be used when a trader believes the stock is going to stay in a pretty tight range. Now, although the risk is
0:20
incredibly low on butterfly spreads, we're not putting up much money for them, the probabilities
0:23
are very much against us. I generally like to think of butterflies as more of like buying lottery
0:28
tickets. For these trades to work out, you basically have to pick a price, usually right at
0:32
the money, where you think the stock is going to be right at expiration. The bulk of the potential
0:36
profit we could make on this trade is really not going to come out until the day of expiration and
0:40
even towards the last couple hours or even minutes of that trading day. So like I said, it's kind of
0:45
like a lottery ticket. We're not only picking the price where we think the stock is going to be, but we're also picking the day and even time of day that we think that's going to happen
0:51
So like a lottery ticket, really low risk. We're putting up very little money up front, but a high reward if we're actually right. Now, since the likelihood of you getting anywhere near
0:59
max profit is incredibly unlikely, you're usually going to set a much lower profit target on these
1:04
trades. A lot of traders out there will close these out when they're even at 25% profit
1:08
maybe a little bit more, but 25% would be a very successful trade for a butterfly
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Now, that was the absolute basics of a butterfly spread and kind of how they work. And I know I
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went through that pretty quick, but don't worry, we're going to spend plenty of time going over these so you guys feel comfortable doing them on your own when we're done here. But now that we got
1:24
that out of the way, let's go ahead and move on to actually creating a butterfly spread in the
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Thinkorsome platform. So to do that, let's come on up here to the trade page, second tab at the top
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and then make sure we're on the all products page. Now on this page, this is where we can actually
1:37
see all of the available expirations, in this case for Rocket. So down below we can see we've
1:41
got 18 February, 25 February, 4 March. And if we decided to put on a butterfly, we simply need to
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click on one of these guys. So let's say we were looking at 4 March. We're going to go ahead and click on that to open it up. From there, I can now see all of the available strike prices for
1:54
the 4th March expiration on Rocket. Now to actually create the butterfly spread inside of here it's
1:59
actually incredibly easy and there are a couple different ways to do it. But for the most part
2:03
what we're going to do is simply find the strike price where we think the stock is going to be on the 4th of March. For this example let's say I'm incredibly neutral on Rocket. I don't think
2:11
it's going to do much of anything between now and the 4th of March. So we're going to look right here
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at the $12 strikes. For this one we're looking at the put side and all I want to do is go ahead and
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right click on that strike price where we think Rocket is going to be on the 4th of March
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So we're going to go ahead and right click on the $12 strike. I'm going to come over here to buy and I'm going to find butterfly down here below
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As soon as we clicked on that, you can see a butterfly spread gets built out for us automatically
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down below. So it kind of does all the work for us. Now, right now, by default, it simply goes one strike out on either side
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So it sells our two where we think Rockets going to be. And then it goes out one strike above and one strike below buying those contracts
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Now, let's say for this first example, we actually wanted to leave it as this just 50 cents wide
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looking to the right hand side you can see the total cost for this butterfly spread is only going
2:56
to be four cents so that's the absolute most we could ever lose on this trade now in the case that
3:00
we're right and we're exactly right rocket is exactly 12 a share on the 4th of march the absolute
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most we could make on this trade is the width of our spread in this case it's 50 cents so if the
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most we could ever sell this thing for is 50 cents and we paid four cents for it the most we could
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actually ever make is going to be 46 now i did all that math in my head but if you come down here to
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confirm and send it will just spell it out for us right here It says max profit 46 bucks max loss If we wanted to tweak this a little bit so let come down here to edit Let go ahead and widen out these wings Instead of being 50 cents wide I going to make it a full dollar wide So I going to change this to 13
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bucks and I'm going to change this one to 11. Now looking on the right hand side, we can see the
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total cost for this dollar wide butterfly is going to be 23 cents. Now since we made it a dollar wide
3:44
butterfly, that means the most we could ever sell this thing for is going to be a dollar. Since we're
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going to be paying 24 cents for it, we know the max profit on this butterfly would be 76 cents or
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76 bucks. And if we came down here to confirm and send again, we could see it spelled out once again
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max profit 76 bucks. So it does all the math for us. If we wanted to see if we were to bump this
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up, let's say if we wanted to bump it up from one contract to let's say a few more. There we go
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Now you can see here, we're about to buy five butterflies and it might be a little bit confusing
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because it says five here, but 10 here, but we're going to look at the long contract number to see
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how many butterflies we're actually putting on. In this case, now that we're buying five butterflies
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it's going to be five times $24 for this entire spread. And then for the max profit, it's going
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to be 76 bucks times five to get our max profit. So I don't want to do the math in my head. We'll
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just hit confirm and send. And now you can see the total max loss on this trade is 120 bucks
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where the max profit is 380. But you can see creating butterfly spreads in here is actually
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incredibly easy. Let's go over a couple more examples just so you guys get the hang of it
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So let's go ahead and delete this out of here. And let's even flip to a different stock ticker
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We'll come over here to, let's say, Disney. Now that I clicked on Disney, we've got the Disney
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option chain opened up here on the right hand side. Let's go ahead and flip it over to 25 February
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instead. And just like before, we're going to put a butterfly right at the money because we're
5:00
pretty neutral. We don't think Disney is going to do anything in this case. So let's find the
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152 and a half puts again. We're going to go ahead and right click on those at the money puts
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we're going to say buy, and we're going to say butterfly once again. Just like before
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you can see it defaults to going one strike out of the money on either side, but in our case
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we're going to make this, let's say, 10 points wide. Now, the wider we make it, the more we're
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going to be paying, but that also increases our potential profit on this trade. So you can see
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right now the amount that we're risking is only 38 cents, but we could make a total of, let's see
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$212 if we're exactly right. If we were to come down here and widen this out, let's change this
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to 10 points wide. That'd be 162.5 and 142.5. I can't get exactly 10 points wide. Let's change
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this a little bit. Make this 160 and 140 here. Now you can see that I've got a much wider butterfly
5:50
spread. I'm risking 435 bucks on this thing, but if I hit confirm and send, my max profit is now 570
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I've also increased the probabilities on this trade because obviously it's a lot more likely
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that Disney will be between 140 and 160 than it is that it'll be between 152.5 and 147.5
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I believe is what we had before. But again, we can see right here, my max profit 570, my max loss 430
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And if I actually wanted to submit this, we would simply hit send down here below. So I think you guys get the idea
6:17
of placing them in here pretty straightforward. It's nothing too crazy. Just right-click on the strike
6:21
where you think Disney or whatever stock it is that you're trading, where you think it's gonna be on expiration
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then say buy, butterfly, pretty straightforward. From there, once you actually bring up
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the order ticket, you might just need to change the strike prices if you want to widen them or
6:33
tighten them, get them exactly where you want them, but putting on the butterfly spread is incredibly
6:37
easy. Now, like we mentioned before, once you actually put on these trades, I can almost
6:41
guarantee you you're not going to take them on until the date of expiration. So if I were to
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actually buy this 25 February Disney butterfly spread I probably am not going to be taking it off until the 25th of February That really when all of the potential profit comes into this trade Now you could get out of it earlier than that
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for 25% profit, or maybe you're only wanting to get 5% profit out of it
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but really, if you wanna get anywhere near your max profit potential, you have to hold it until expiration
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For us to actually see this, let's go ahead and right-click on this trade, and we're gonna say yze trade
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As soon as we do that, it takes us to the yze page, and in my case, I'm on earnings
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but I want you to come over here to risk profile specifically. Once we come to this page, we can
7:19
actually see a visualization of exactly how much money we're going to make or lose on Disney in
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this case. Now, usually it would just show you the butterfly spread, but I actually have a long
7:28
position on Disney. I've got a hundred shares of it. So what I need to do is actually come down here
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and uncheck my position. And now I'm only looking at the butterfly spread for this trade. Right up
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here at the top, we can see our risk profile. So exactly how much money we're going to make or lose
7:40
depending on where Disney stock goes. If you guys take a look at where I've got my mouse right now
7:45
145.92, and you look in the lower left-hand corner, it tells you exactly how much money I would have made
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or lost on this trade on both today and the date of expiration. So for today, February 14th, it's saying
7:56
if Disney was at 145.92, I would theoretically be able to sell this thing
8:00
for a $14.45 profit. If I were to instead hold it all the way
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until expiration, February 26th, and Disney was at 145.87, I would be up $157 on this trade. If I were to move my mouse to the right, you can see where
8:13
this trade peaks out, and that's going to be exactly where we sold our two strikes at the
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150 strike. You can see there that's where I make my max profit, but that peak doesn't happen until
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the date of expiration and even the last couple of minutes until expiration. The purple line
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instead tells us that if I were to do that today, February 14th, I would only be able to close it
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out for a profit of $37. And if I come down here to my calendar icon and I start fast forwarding
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in time, you can see it takes a whole long time for that purple line to match up with the blue line
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And even if I go back to February 25th, remember that's the morning of expiration, I'm still not
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even close to my max profit. Even if Disney is exactly where I think it's going to be, $150 a
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share on the 25th of February, right in the morning, I'm still only up $380 on this trade
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To get the last little bit out, the last $200 out of this trade, I have to hold it all the way until
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the last couple minutes of trading. And that's why most traders are not going to try and get
9:05
anywhere near max profit. That's why they're going to say, hey, if I'm ever at a 25% profit on this
9:10
butterfly, I'm just going to go ahead and close it out. Some people are willing to hold it all the
9:14
way up until the last few minutes of trading and see if they can get out that last little bit of
9:17
premium. But for the most part, you're probably closing it out well before then. But let's take
9:21
a look at another example, just so you guys get the hang of it. Let's come over here and we'll do
9:25
the same thing for Coinbase. Currently trading at 204.55. We'll go back to the option chain
9:30
Let's first go ahead and delete out this Disney butterfly spread. And we're going to use the same
9:34
expiration 25 February. Now instead of picking a strike right at the money, let's instead say you
9:40
thought it was going to go down to 170 by 25 February, and we wanted to bet on that. So what
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we're going to do is go ahead and right click on this thing. We're going to say buy butterfly, just like before. Like in all the previous examples, it goes one strike out of the money
9:52
So right now we've got the 170 strike and we bought the wings two and a half points out
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If we wanted to give ourselves a little bit more wiggle room, let's change this to five points wide
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So 175 and 165. There we go. Now on the right hand side, we can see our total loss on this trade
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If we're completely wrong, would be a 30 cent loss or 30 buck loss. However if we right remember we could sell this for five bucks because the spread is five dollars wide or four hundred and seventy dollars a profit and just like in the previous example if we actually wanted to visualize this trade take a peek at it we can just right click on it and say yze trade
10:24
from there just like before it takes us to the risk profile page and you can see all of my
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positions on coin so let's go ahead and uncheck the two that i have and now we just have the
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theoretical butterfly here you may also notice that it's not centered on my chart right now so
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Let's go ahead and drag this over, actually center up this butterfly here. And now we can see our exact risk profile on this butterfly spread
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And you can see that the risk reward is pretty skewed, right? Because we're only risking 30 cents for the potential to make $470 in profit if we're exactly right
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Now, in terms of managing them, I already told you that for the most part, you're probably going to close these out when you're about 25% profit or so
10:59
That'd be a very successful trade in this case. But I also want to make it very clear that you guys need to close these out before they actually expire
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So let's say you're holding this thing, the market closes in about an hour, and you're looking at this thing and going
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man, I am willing to hold it right up until expiration because I think I'm going to nail this thing
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I think I can get pretty darn close to getting near max profit, let's say 90% or 85%, something like that
11:19
But you really need to make sure that you do close it out before it expires. So be ready
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Make sure if you are planning on selling it, you are ready to sell it. Because if you let this thing expire
11:27
you could be assigned a couple hundred shares that you might not be expecting. But that's pretty much it in terms of managing them
11:32
Make sure you close them out before they expire. if you hit 25 profit you probably just want to close it out otherwise you're going to have to
11:38
hold it right up until expiration even the last few minutes of trading just to get that last little
11:42
bit out of it now the last thing i'll also mention is in terms of which strikes or excuse me which
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expiration you want to pick so let's go back to the trade page for a second for the most part
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you're not going to go too far out in time when you put on these butterflies like it wouldn't make a whole lot of sense to go out all the way to 18 march or 14 february usually you'll probably stick
11:59
out maybe a week or two. As you get closer and closer, yes, they will get a little bit more
12:03
expensive if you're picking right at the money. But if you were to go out, let's say 10 days or
12:07
17 days, these are pretty darn close to the same pricing model. So if we were to compare the two
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let's say we put on a at the money butterfly for 25 February, 10 days out. We're to come down here
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to the 205 strike and buy one butterfly. You can see the total cost of this thing. And again
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this is a two and a half point wide butterfly would be 20 cents. If we were to instead go out
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let's say 17 days, which remember, if you go further out in time, it's probably more unlikely
12:31
that coin is going to stay exactly where it's at for 17 days and 10 days. But if we were to go out
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to the same strike price, 205, and buy a butterfly here instead, you can see that the cost is
12:41
relatively the same. I know the bid-ass spread on these is kind of wide. So in reality, you probably
12:45
feel roughly the same, probably like 30 cents or so. So for the most part, you'll probably stick to
12:50
this time period, maybe 10, 20 days out. You probably won't go any further out than that
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And then in terms of picking the strike that you want to choose, usually you'll do right at the money if you think the stock will stay pretty much the same
13:01
Or if you thought it was going to go down or up, you could pick the strikes that way. But like we've said a hundred times, these are really like lottery tickets
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You're basically trying to decide exactly where you think the stock is going to be on an exact day at an exact time
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So really just go into this knowing it's a very low probability of success, but a very low risk as well
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Now, I do know that was a lot, but hopefully that gives you guys a better understanding of how butterfly spreads work
13:23
and how you can place them in the Thinkorsome platform. If you guys have any additional questions for me
13:28
or recommendations for future videos, please leave it down below. And also be sure to check out
13:32
some of my other Thinkorsome tutorial videos if you guys wanna learn more. But otherwise, I'll go ahead and wrap things up here
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I hope you guys all have an amazing rest of your week and I'll catch you all in the next video
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