Matt Baker
Matt Baker

Welcome to part 10 of my series of articles on the Butterfly. In this week’s article, we will continue looking at the Risk Graph page. We will work with the same Butterfly we have been working with throughout the series, the AAPL (Apple Computers) Oct 09 155|175|195 Call Butterfly. At the time we constructed the trade, AAPL’s price was about $173. Let’s have a look at the top part of the Risk Graph page, with the trade leg details, trade cost/risk amounts etc, and Greeks. In the last article we looked at the columns Vol, OI and Days.

Chart 1

click chart for more detail
click to enlarge

We will continue now where we left off. Please look at the area below all the trade legs where it says Quote Type, Entry Debit, Profit, Max Profit and Max Risk. Let’s start by learning about Quote Type. There are different ways Platinum can display / calculate the quote of an option or trade. When you select Natural (instead of Mid Quote) you are taking all possible slippage into account.

For example if the options quote was $1.50 / $1.70, and you were buying the option, the Entry Debit would read $170 and the Profit column would read $-20 (representing $20 of slippage, the difference between $170 and $150). If however we used Mid Quotes here, Platinum would slice the bid / ask down the middle, and the Entry Debit would read $160, with a Profit of only $-10, representing only $10 of slippage, the difference between $170 and $160.

If you think you will be able to shave the option(s) significantly when placing the order, then using the Mid Quotes may give you a closer idea as to how the trade is going to look. Natural Quotes would be the conservative quote type of course. The way I think of the Profit column, is “If I had to close the trade today, sell what I bought, and buy back what I sold, what would my net position be?”

The Max Profit Column is simply telling you the most you can make on the trade, should everything go your way. The Max Risk column is the most important one of all. This column tells you what the most is you could lose, should the worst happen. We should always plan for this. Sometimes the Max Risk column is greater than the Entry Debit, or could even be smaller, but at the end of the day, what you can lose in the trade is in the Max Risk column, not what the Entry Debit column is telling you.

We will continue with the Risk Graph analysis in the next part of the series.

Manage your trades!

Matt Baker