Trade The Journey

Trade The Journey

Trade Management: Butterfly “t” 18.5 Brought Call/19 Sold Call/19.5 Brought Call

This week, I’d like to talk about remaining flexible and adapting to a challenging situation. Earlier this week I found three possible trades that had a high possibility of ending profitably.  The first trade I found was Alibaba which I thought could break out of its trading range.

The put/call ratio and volume/open interest ratio were low and the overall sentiment on the option I was looking at was bullish. A possible plan of action was bullish debit spread but I passed on the trade in favor of another trade.

Underneath the bullish put/call ratio was a big move that occurred at the beginning of the week. Alibaba announced early in the week that they planned to split the company into six parts and the markets reacted positively to the news. This trade would have been ideal had I would have took the position. Alibaba gapped up several dollars.

This is why it’s important to look at the information presented on the option chain like put/call ratios, options volume, volatility, and the Greeks.  The market speaks but to interpret the message you have to look deeper into the volume and price action.

Daily chart of T: after close on expiration date

I decided to trade a slightly bullish butterfly on AT&T (T). T has a low beta and doesn’t move much throughout the week like other high-flying options.  The trade started a bit shaky and I almost closed it on the first day. The butterfly premium dropped several times, but I decided to hold it.

A butterfly trade means that you are primarily neutral on the stock’s movement. I checked the ADX and on the daily chart, the trend was neutral with an ADX below 20. The RSI was around fifty which showed me that the momentum of the stock was increasing.

T moved to the inside strike the next day. The goal is for a butterfly is for the stock price to land as close as possible to the inside strike by expiration. The option expiration was at the end of the week so the position required management. The following day, I wasn’t sure if I’d have to close the position. One aspect of the trade that worked in my favor was that T didn’t move much. The 2-month beta for T was 0.66, meaning that when the indices moved a full point, T would make two-thirds of the move.

There were several economic data reports to be released throughout the week with the potential to move the market in either direction. The GDP, PCE, Chicago manufacturing, and the final reading of the University of Michigan consumer sentiment report. The initial claims are released every week. All these reports served as indicators of the Fed’s possible rate decision for the next Fed meeting.

At first, I was hesitant to put on the trade because of the possible market volatility. You’re really taking your best guess on how the market may react to the economic data releases. The week started with the market showing some calm after the collapse of several banks. The Fed pledged to assist banks with needed liquidity and institute some form of deposit coverage.

The very next day, the butterfly position closed a bit above the option premium price I paid as T remained close to the inside strike. If the stock price is close to the inside strike, the butterfly will become more of a short position, earning time value as you get near the expiration date.

The butterfly option position is a test of patience and accuracy. With the position needing to be at the inside strike by expiration, there shouldn’t be much price movement. If the stock price moves past either the long call that’s in-the-money or out-of-the-money, you’ll lose money. The day before the expiration date, I had a small profit that I could have taken but I decided to let my profits run as they say.

On the expiration date, I was sweating bullets because I didn’t know how the PCE report would turn out. If the PCE came in higher than forecasted, we could be looking at another interest rate hike which was the opposite of market expectations of a rate cut later this year.

The PCE came in below expectations and T moved up and beyond the inside strike. My goal for this trade was to close it above the $100 profit level and I thought my chances were good.

5-min chart of T:

Here is where the fun begins:

I couldn’t close the position as the T butterfly position reached my desired profit level. The agony I felt as I watched the option premium gyrate between my profit target and the premium at the open was intense. At the least, I could close the position at the $50 level. I mean it’s a nice profit but this time I wanted to let my profits run and reach my profit goal for the trade.

Cutting your losses and letting your profits run can be one of the hardest trading skills to acquire. I felt my stomach turning as the premium reached my profit level, but I couldn’t exit. Little did I know, butterflies are extremely hard to close, and my position was no exception. The out-of-the-money call had no action, plenty of buyers but no sellers.

There were no buyers when I attempted to sell the butterfly position. As the two calls I sold began to go deeper into the money, I knew this position would lose most of the profits if I didn’t close it. Stressed out, I even reached out to the trading platform help chat to figure out why I could not get out of the position.

It wasn’t their fault, but I didn’t know what to do at the moment. The butterfly position remained open as the T stock price made new highs of the day. Since I couldn’t exit the position, I figured it might be best to leg out. Legging out of a multi-leg options position can be treacherous because you have to or I had to buy the short call back before selling the long call.

I watched the short call price reach a high of 0.20 and if I closed here that would be a major setback so I had to wait. Patience is not a strong suit of mine, so you can imagine how difficult it was for me to sit on my hands. I knew the short call would not revisit the low of 0.09 of the day so I had to close the position at 0.17. I had to wait a couple of hours for the short call price to return to 0.17 as I felt my palms began to sweat.

I also couldn’t exit the short call at a higher price of 0.18 to get out because I didn’t have enough capital in my account. I tried to add the needed capital but my phone kept freezing and I was having trouble with my internet connection on my laptop. Everything was going wrong.

Finally, there was a pullback in T stock price, and I was able to exit at 0.17. The next part was closing the long-in-the-money call at the best possible price. The in-the-money call had a delta of 0.92 meaning it was close to moving with T at 1:1. When the option moves to 1.00 delta, it essentially moves as the stock moves dollar for dollar. T kept reaching the high or near the high of the morning and retreating. On top of this, the long call bid-ask spread was about 0.12 cents wide which means I couldn’t close near the ask. I tried but never got filled.

My goal was to close the long call at 0.72 or higher but it never happened and because T had a low beta it didn’t move as much as the rest of the market. To add to the challenge was the fact that volume in T had slowed in the middle of the day as it always does.  The open and near the close of the day usually have the highest volume.

Ultimately, I settled at 0.70 and the butterfly position was all but closed except for the out-of-the-money call which was about 0.01. It never moved so I decided to let it expire worthless.

I ended up with a profit. I was able to buy the short call back for a total of $204 and sell the long in-the-money call for a total of $424. The out-of-the-money call sold for less than $6.

When the position closed, I breathed a sigh of relief.  This is why trading is so difficult. If I wasn’t flexible enough to adjust while managing the trade, I would have let the trading platform close the butterfly at a far lower premium. It also would have affected me negatively emotionally because I knew that I was close to closing my profitable trade above $100.

Letting your profits run can be very challenging because you never know what’s about to happen next. Leaving your position open leaves, you open to some surprise new event or another market event like a seller, selling a large amount of stock resulting in the stock price dropping.

This is one of the reasons why completing your homework nightly is so important, it prepares you for the various scenarios that could occur the next trading day.

Today was very important to my development as a trader. It showed me the importance of being flexible and remaining calm in the midst of uncertainty.


Leave a Comment

Your email address will not be published. Required fields are marked *