VIX Butterfly

Written on May 15, 2007 by OptionsRopeaDope

I’ve become very interested in Butterflies recently, especially reading about Market Wizard Tony Saliba. I thought this might be a strategy, much like a box, that only market makers can take advantage of, but I’m finding that is not the case after looking around a little bit.

 The key to making a Butterfly work is to get in with as small a debit as possible, and to have a substantial risk/reward ratio. If you price butterflies on most stocks or indices (2 shorts at the money, with one long ITM, and one long OTM) you’ll find the risk/reward is 1/1 or worse (just try it). However, there are still rare ones out there, including one I just opened.

(By the way Butterflies can be either all calls or all puts, and if opened that way as a single order, only result in a debit, which is the max that can be lost. An Iron Butterfly is a put credit and call credit spread, which although it has about the same profit profile, demands a higher margin.)

The VIX yesterday had the May 13 VIX at .35, the May 14 VIX at .1, and the 15 May VIX at .1 (bid-ask spread explains the price discrepancy.)  According the rules, I can purchase this at a debit .25 - with a potential profit of .75 - for a risk reward ratio of 1/3 - pretty nice.

Essentially my profit range is if the VIX ends between 13.25 and 14.75 - a nice range, and a potential to at least double my investment if it ends between 13.5 and 14.5.

Already learned a lesson here - a secret to making this work is a wide range (which is very difficult), and it really needs more time than I’m giving this one (which is 5 days). Still, this one is good - a little risk for a potential substantial gain, unless the VIX jumps big time on Friday.

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