The time bomb butterfly

February 22, 2016 11:00 AM

The butterfly is one of the most popular options strategies. There are many different structures for a butterfly, from neutral to more bullish or bearish structures. Also, in the set-up you can have iron butterflies that involve the selling of a put and call vertical and also the all-call or all-put option butterfly.

One of the best butterfly strategies is what we call a “time bomb butterfly.” With this strategy you will be buying an all-call or all-put butterfly in an expiry and a strike price of your choosing. Here are two examples.

The first is an earnings play — one of the best times to use the time bomb butterfly. With their recent earnings report, GOOGL made a large move to the upside. 

The day before the earnings release we purchase an all-call butterfly centered 50 points above the current market price. With GOOGL trading at $680 our all-call butterfly is centered at $730.

The number of contracts and the width of the fly are up to you. The more contracts and the wider your fly the more expensive the fly will be. In this example, we have 10-point wide wings. The trade put on in this manner can be done very inexpensively. On Oct. 22, we buy a 740 call, a 720 call and sell two 730 calls for $3.25 for a minor net debit. 

This will generally be a binomial trade, meaning you will either win or lose all of your investment, so it is best to keep these trades small. After putting this trade on the night before earnings, GOOGL was up more than $52 the day and we had a 1600% profit: The 740 call is $3.35, the 720 call is $14.45 and the two 730 short calls are $745. 

It’s time to close the trade. Of course GOOGL just as easily could have gone down and we would have lost our investment, so its best to keep your investment small. 

In our next example, we will use an all-put time bomb butterfly to speculate on the overall market direction using the SPX. Here we bought an all-put butterfly on Nov. 6, 40 points below where the SPX was trading and one week before options expiration. We set the fly up with 20-point wings.

This trade was entered on a Friday. On Monday morning, even though the price had not yet entered the body of our fly, we still had a hefty profit.

Indeed, you may even want to close the trade here or since it is such a low investment, in this case less than $100 for the butterfly, we can wait until later in the week because, as we get closer to expiration, more profit will accumulate if we are inside the body of the fly.

By Friday morning’s open — which is when these SPX options expire — the SPX was trading around 2040 and we were up more than 800%.