Welcome to Part 17 of my series of articles on the Butterfly. In this weeks article we are going to continue looking at the Greeks of the Butterfly case study we looked at in Parts 15 and 16. The case study was taken from LiveTrade www.optionetics.com.au/livetrade7days
Chart 1 and 2 show the risk graph of the Butterfly. Last week we looked at Delta, and talked about the Delta of 6.05. We usually know a Butterfly to have a neutral Delta (as close to zero as possible), but this Butterfly was constructed with a positive Delta because we were bullish on the stock. This means that if HES goes up $1, we will make $6.05.
In this week’s article we are going to look at the greek Theta. In chart 1, we can see Theta has a value of $0.96. This is telling us that we will make 96 cents the next time the sun comes up. We are making money because Theta is positive. If Theta was negative, it would mean we were losing 96cents cents. Theta will change however, as the stock price changes. 96 cents may not sound like much but if the stock does move up, Theta will increase, and will be the greatest when the stock hits $65, where the short strikes are.
click to enlarge
click to enlarge
There are actually parts of the Butterfly where Theta would be negative. From below approximately $60 in stock price, Theta will start to become negative. Where this actually happens is the point where all the coloured lines converge. From that point and lower, Theta will go from being positive to negative. In trade management, this could represent a good time to close the trade. The trade will be in about 25% loss, and we’d now be losing money from Time Decay.
This is an example of using the Greeks to help you with trade management. Naturally we cant solely rely on the Greeks. If getting out when a certain Greek did this or that meant losing too much money, we may have to revisit the plan. Also, don’t forget that the Greeks change as the trade matures, so a particular point you had in mind to exit a trade at the trades inception may look a lot different a few weeks on, if you solely go by the Greeks. A solid understanding of the Greeks is certainly necessary for adequate trade management. As mentioned the IOT (Interactive Options Trading class) gives students a very solid understanding of the Greeks and how to use them in your trading.
Manage your trades!