Butterflies aren’t free
Because you’re able to calculate an accurate target ahead of a catalyst event, you can set up advanced strategies that allow for a huge profit potential on invested capital. Butterflies are an example of a spread that uses a specific target yet still profits within a range. Using the measured move target can greatly increase your chance of success when trading butterflies.
A butterfly basically is a combination of a long and short vertical spread. For example, a call butterfly would involve buying the E-mini 1715-1720-1725 call butterfly for 0.25. Here, we are buying the 1715 call, selling two of the 1720 calls and buying the 1725 call. This sets up the same as buying the 1715-1720 call spread while selling the 1720-1725 call spread. The risk for this trade is $12.50 per one-lot, with a potential reward of $237.50. Breakeven is at 1717.25 and 1724.75.
While butterflies usually set up for large reward-to-risk ratios, the profit potential of this trade is not typical. Returns in the area of eight- or nine-to-one are more typical. Again, sell the strike closest to the upside measured move target. In this case, it is the 1720 strike. “Call butterfly profits” (below) illustrates the profit zone for this trade.
In a put buying example, we would buy the E-mini Aug. 9 weekly 1685-1680-1675 put butterfly for 0.30. Here you would buy 1685 puts, sell two 1680 puts and buy 1675 puts. This sets up the same as buying the 1685-1680 put spread while selling the 1680-1675 put spread. The risk is $15 per one-lot. and the reward is $235 per one-lot. The breakeven is 1684.7 and 1675.3. “Put butterfly profits” (below) shows where the market must move for this trade to be profitable.
Using the downside measured move target, you’re able to set up a bearish trade with a great reward potential.