Butterfly Spreads and Understanding the Strategy
Potential Profits
If you can time when this move is going to happen and particularly where it’s going to be at, you can make a lot of money.
Considerations for the Strategy
There’s a lot of things that you have to consider when running this strategy, and I’m going to teach you guys how to do that in this guide.
Personal Motivation
My goal is really to help as many people as possible. I love to hear positive stories and people making good choices and making profits. That’s what drives me. So let’s get right into the strategy.
Butterfly Spreads Explained
Introduction to Butterfly Spreads
We’re going to talk about butterfly spreads. Let me show you how we can run this strategy, how to set it up, and how to pick the proper candidate.
Disclaimer
I just want to point out that I’m not a financial adviser, and this is not financial advice. I’m here to give tips, strategies, technical’s, fundamentals, and financials. However, it’s ultimately up to you to decide which stocks you want to buy and how much of a position size you want to have in that stock or option, as it’s your money.
Choosing the Right Stock
Before we can run this strategy, we have to pick a stock that is likely to go up or down—bullish or bearish, it does not matter. So we’re going to start off with Nvidia.
Analyzing Nvidia
We can see here that it’s in an uptrend, although it could pull back in touch again. We have one, two, and there has to be three touches for conviction. So we’re going to have a pullback at some point in the next 2 to 3 weeks. Nvidia is going to pull back to $110, $112. It’s somewhat likely, but we shall see.
Technical Analysis
We’re going to look at the chart, look at the EMA, and we can see the 10 is above the 20, and the 10 and 20 are both above the 100. We can see it’s in the middle of the Bollinger Band, so that’s good.
Setting Up the Trade
We’re going to set where we think it’s going to go, and I would say that in the next week, $125 is likely, and $122 is even more likely. So let’s go with $122 by next week. This is where I think it’s going to go by the end of this week or next week.
Executing the Strategy on Robinhood
Selecting the Expiration Date
We would come into Robinhood, pick the expiration date June 21st, next week, click on sell, click on call, click on the price that you think Nvidia is going to go to, $122. Then we’re going to buy the $123 and we’re going to buy the $121—one leg above, one leg down.
Customizing the Contracts
Then we’re going to click to custom so you can customize how many of each contract. Since we have two buy contracts, although different strike prices, we only have one sell, so we’re going to pick this one, highlight it, select two, and look what happened. Click continue.
Scaling the Trade
We’ll go with 10 contracts. And all that has to happen is Nvidia just has to go to $122 and end there on expiration or as close as possible.
Evaluating the Strategy
So in the next 8 days, will Nvidia go up a couple of dollars and settle there or stay somewhat close? That’s the question. Do we think it’s going to go to $124? Do we think it’s going to go down to $118? This is how the strategy works.
Potential Profits with Different Outcomes
Even if Nvidia only goes to $120.15 by next week, we make $461. But we can decide where we think the stock is going to go price-wise by setting this up, and we get to choose our expiration of when we think it would happen.
Adjusting the Strategy
Going Further Out in Time
If we want to go further out to July, we would click on sell, and let’s say we think it’s going to go to $124. Sell $124, buy $125, buy $123. Click custom, click on two.
Evaluating Different Spreads
All Nvidia has to do is go to $124. Our range is $123.03 to $124.97. So basically, $123 to $125 in that $2 range, we make profit.
Comparing Returns
We can also spread this out an extra dollar. Now the range is $122 to $126. This is a lot better. It’s $2 less to make more profit. It’s $2 less because the spread is bigger.
Understanding the Spread
We’re selling the $124, buying the $125, buying the $123. However, if the price lands below $123.03 or above $124.97, we make nothing.
Wider Spreads
If we open the spread up between $126 and $122, giving us a $4 spread, our break-even is now $122.10 and $125.90. If the price was to land at $122.60 or $122.55, we make $44. If we do a $100 spread, we make nothing if it lands at $122.55.
Choosing the Right Spread
It gives us more room. If you’re convicted where the price is going to go and you think it’s going to be right around $124, there is more profit potential. However, if you want something more safe, a wider range like $122 to $126 gives you a $4 range that the price can go in.
Applying the Strategy to Palantir
Introduction to Palantir
You can see how powerful this strategy is. All we have to do is have an estimate of where we think the price is going to be, and with Nvidia, it’s between $122 and $126. As long as Nvidia ends up in between these two lines on Friday or Friday of next week, anywhere in between, we’re making profit on this strategy. The closer it is to $124, the more profit we make.
Visualizing the Price Range
There’s a $4 movement. That’s a decent amount of room to move. As long as we’re in between this $4 price range, we’re making profit. This is a very good strategy.
Setting Up the Trade on Palantir
Now another ticker: Palantir. I think we’re going to end up around $24–$25 around June 28th.
Executing the Trade
So let’s do $25. Sell $25, click buy, buy the $26, and then buy the $24.
Evaluating the Trade
There’s almost a $2 spread, which is really good for Palantir. We’re putting up $17, and once Palantir crosses $24.17, we’re making profit.
Visualizing the Profit Potential
This is between $24 and $26. All we would need to happen is Palantir just has to go up and cross over this range by Friday, and we’re in the profit. That’s it.
Profit Calculation
All the price would have to do is go right about there by Friday.
Risk Management and Strategy Insights
Personal Experience
I actually ran the strategy a couple of times in my large portfolio recently, and I’ve made good money.
Visualizing the Strategy
All it has to do is just cross over this line, and anywhere we’re making some form of profit. If it goes higher, we’re making even more. You can run this as a bullish or a bearish strategy, but you have to risk manage.
Understanding Risk
This is not going to have a 100% win ratio. This is probably going to have a ratio of 50 to 60 wins out of 100. However, it’s so cheap. You have to manage your risk, but you can’t lose any more than you’re purchasing.
Realistic Expectations
You’re probably never going to get the exact peak. The price is never going to close on Friday right at the peak. You’re going to end up closing Wednesday, Thursday, sometime Friday somewhere else where you’re making 50 to 60, maybe 70% of the profits or more. Usually, I close early, 2 to 3x, and then I’m out. Really what’s going to happen is you’re going to end up opening this position on a Monday, and by Wednesday or Thursday, you’re going to close it for a profit.
Strategy Effectiveness
Some of the trades are going to be a little bit riskier than others depending on the stock, but this is a phenomenal strategy.
Profitability Analysis
Five times you spend $17 and lose, you lost $85. Five times you do this and you make, let’s say a little more than half, you still profit significantly.
Win Rate Impact
That is why this is so powerful and one of the best strategies that you can implement into your portfolio.
Comparison to Other Strategies
Similarity to Iron Condor
This strategy is somewhat similar to an iron condor, although a lot cheaper, and it’s a debit strategy versus a credit strategy. This butterfly doesn’t require any collateral. You’re just spending the upfront money, $5, $10 to open the contract.
Risk Considerations
There are risks, just like any other strategy, and that’s understanding the underlying stock that you’re trying to execute the strategy on. If the stock is moving very volatile up and down and it’s just all over the place, it’s a bad idea to run the stock. You want to run it on somewhat consolidating stocks, right after earnings. This way you have more predictability on where the price will go. Make sure you check your EMA, your Bollinger Bands, and things like that so you have a good understanding if the price might be reversing or might be continuing in an uptrend.
Conclusion
Final Thoughts on the Strategy
This way you can time it properly and get that correct along with where you think it’s going to go in a certain amount of time. As you can see how powerful this strategy is, as long as you’re pretty sure on where the price is going to go and when it’s going to happen, you can make a lot of premium and profits with butterfly spreads, Also read this.