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2019issue C0930-31

Failed breakout as a setting for an out-of-the-money put butterfly

A case study uses a failed upside breakout and a low implied-volatility reading as the setting for a July SPY out-of-the-money put butterfly, treating the same 1/-2/1 construction as a directional structure instead of a neutral at-the-money butterfly.

  • An out-of-the-money butterfly keeps the same long-one, short-two, long-one construction and equal wing-to-body spacing as a standard butterfly, but every strike sits away from the money.
  • The case study treats a failed upside breakout, with implied volatility toward the low end of its historical range, as a setting for a directional put butterfly rather than a neutral at-the-money structure.
  • In the July SPY example that buys 288, sells two 264 strikes, and buys 240, the position is described as losing money if the underlying does not decline, while time decay is described as turning helpful once price trades below the higher long put strike.
  • Maximum payoff at the short middle strike is called exceedingly unlikely, so a dollar or price target is the usual management path, and a put-side preference is noted because equities are described as often falling faster than they rise and because the structure typically has positive vega.
Entries in this reading3 entries
Current trackButterfly spread29 readingsOption spread138 readingsImplied volatility analysis176 readings

Same construction, different placement

An out-of-the-money butterfly uses the same long-one, short-two, long-one construction as a standard butterfly, with equal wing-to-body spacing. Every strike is placed away from the money. A conventional at-the-money butterfly is typically framed as a relatively neutral structure meant for an underlying that stays near the middle strike into expiration.

Failed breakout and cheap options

The case study presents a failed upside breakout as one setting for an out-of-the-money put butterfly. Price reaches a prior high and does not follow through, a backdrop often followed by sideways-to-lower trade. After that rally, implied volatility is described as sitting toward the low end of its historical range. The case study treats that reading as relatively cheap options for a net-premium butterfly.

A directional put example

The worked example is a July SPY put butterfly that buys the 288 strike, sells two 264 strikes, and buys the 240 strike. That example is characterized as a purely directional put structure: if the underlying does not decline, the position is described as losing money.

Time decay and the management path

Once the underlying trades below the higher long put strike, about 288 in the example, time decay is described as beginning to work in favor of the butterfly rather than against it. Capturing the theoretical maximum payoff is described as requiring the underlying to settle exactly at the short middle strike at expiration. That outcome is called exceedingly unlikely, so a dollar or price target is presented as the usual management path.

Why the put side is discussed

The case study notes a possible put-side preference because equities are described as often falling faster than they rise. An out-of-the-money butterfly typically has positive vega, and implied volatility often increases when prices decline.

July SPY OTM put butterfly: implied volatility by strike

The three July 2019 SPY puts in the example butterfly sit on a steep implied-volatility smile: the 288 long put was marked at 13.47 percent, the short 264s at 19.38 percent, and the 240 long put at 25.68 percent. Those are the OptionsAnalysis.com leg IVs from the position blotter, not a redrawn curve. The same 1/-2/1 construction that is usually taught as a neutral at-the-money fly is here a cheap directional put: net natural debit $202, max risk $282, max profit $2,116 (about 751 percent of risk), with breakevens at 242.82 and 285.18.
The three July 2019 SPY puts in the example butterfly sit on a steep implied-volatility smile: the 288 long put was marked at 13.47 percent, the short 264s at 19.38 percent, and the 240 long put at 25.68 percent. Those are the OptionsAnalysis.com leg IVs from the position blotter, not a redrawn curve. The same 1/-2/1 construction that is usually taught as a neutral at-the-money fly is here a cheap directional put: net natural debit $202, max risk $282, max profit $2,116 (about 751 percent of risk), with breakevens at 242.82 and 285.18.SPY · 2019-07-19 expiration, entered 2019-05-02 · 2019-05-02T00:00:00.000Z to 2019-07-19T00:00:00.000Z

IV, entry, and P&L figures are the Natural quote snapshot on the blotter dated 2019-05-02, with 78 days to the 2019-07-19 expiration. Max profit and max risk are the platform totals for one 1/-2/1 spread, not a mid-price theoretical.

Educational research material, not investment advice. Historical source context does not establish present-day performance.
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  2. 2006Index volatility alignment, skews, and butterfly construction
  3. 2006Oil proxies, volatility regimes, and bounded overlays
  4. 2007Pairing a double-diagonal overlay with an income butterfly
  5. 2008Range-bound butterfly debit versus iron credit
  6. 2008Iron butterfly payoff construction in volatile crude
  7. 2010Constructing directional out-of-the-money butterfly spreads
  8. 2010Modified butterfly and calendar spreads in high-priced names
  9. 2011Broken-wing put butterfly: credit, vega, and assignment
  10. 2013A live-cattle call butterfly is a different risk object than an outright call
  11. 2017Put butterfly payoff construction from an implied move and premium
  12. 2017One-day earnings volatility, ratio spreads and butterflies
  13. 2017Building a staggered broken-wing butterfly book
  14. 2017Below-the-money butterfly spreads sized by volatility regime
  15. 2018Why day-one option risk curves misread theta, calendars, and butterflies
  16. 2019An expected-value filter for defined-risk option spreads
  17. 2019Failed breakout as a setting for an out-of-the-money put butterfly
  18. 2020Limited-risk call butterfly construction in volatile oil
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