This post is another in a series tracking the hypothetical performance of broken wing butterfly trades selected by Greg Loehr of Optionsbuzz.com.
Throughout this blog I’ve been tracking various hypothetical positions on AAPL, SPX and most recently the SPXPM, using time frames lasting from one week to three weeks. And each time the strategy has been the same: a broken wing butterfly. Most of these trades have been entered into for credits, with one being tracked with a debit entry price; and six winners and one loser.
One strategy, mostly all for credits, similar time frames. One might think that trading a broken wing butterfly is something that can be traded and tracked to profitability much like Suzy Homemaker follows a Wolgang Puck recipe and expects her angel hair pasta to be worthy of critical acclaim. But as anyone who has tried this knows, simply following a recipe does not guarantee any amount of success. My opinion on this is that there is NO recipe (or checklist) that guarantees success, other than perhaps storing water below 32 degrees to make ice, and the same is true in options trading. There simply exist too many variables.
Take the broken wing fly for example. Does a framework exist for identifying potential trading ideas from week-to-week or month-to-month? Yes. I absolutely cover the framework in the four-part broken wing butterfly video series. But a framework, in and of itself, may leave you with questions. And with the potential for Europe to implode, or the US economy to tank, you don’t want to be holding positions with those questions in the back of your mind. On the contrary, you want to be fully prepared to take advantage of what the market brings.
That’s why it’s imperative for every options trader to learn from those that have the knowledge and experience. Just like a chef who distinguishes between different variations of the same spice, did you know that changing even one strike for your butterfly could make a huge difference in the outcome of the trade? Or, that synthetically creating a strike that doesn’t even exist may be the best decision you could make?
That’s why an hour of mentoring is included with every broken wing butterfly video series. It’s designed to make you a better trader; to explore the areas of trading that you might not have ever considered. One topic that can be covered in my mentoring sessions is “position sizing”. That is, how many contracts does one trade? The answer may not be subject to the limitations of a recipe or checklist. So here are some of the things to keep in mind when you’re looking at a potential trade:
1. Risk should be considered from the standpoint of a percentage of your portfolio. One good, but very general rule, is to keep your trades equally dollar-weighted using, for example, 5% of your portfolio as the risk per trade. The reason for this rule is so that one losing trade doesn’t overwhelm your previous four winning trades just because the losing trade risked so much more money than the other trades did.
2. Rule #1 will start to change as you learn to distinguish and manage trades based on “real” risk versus “theoretical” maximum risk. Generally speaking you should never allow any trade to hit maximum theoretical loss unless you’ve learned rule #3.
3. Depending on the “real” risk in a trade – that is, the amount of money one could lose given a certain set of market parameters – one should allocate higher amounts of money to trades with lower real risk, and lower amounts of money to trades with higher real risk.
Applying #3 to recent trades I’ve tracked here, consider that the recent broken wing butterfly on AAPL is being tracked for a debit. Since this trade couldn’t be entered into for a credit I knew that there would be a high potential for losing that debit if AAPL didn’t go up. So this the kind of trade where one would risk only a very small portion of the portfolio – perhaps only 1% – because of the real risk of losing the debit. Compare this one to the SPXPM butterfly where I’m tracking the risk of one-third of an imaginary portfolio, but with a high probability of keeping the entry credit. Two polar-opposite types of management, but on very similar strategies whose differences would be practically undetectable to a novice trader.
Bottom line: this summer’s trading could be ripe for potential with rising volatility and the macro-economic environment very much in flux. Just remember that “chance favors the prepared mind”
Trade safe!
Greg Loehr
Please note: Hypothetical computer simulated performance results are believed to be accurately presented. However, they are not guaranteed as to accuracy or completeness and are subject to change without any notice. Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Since, also, the trades have not actually been executed; the results may have been under or over compensated for the impact, if any, of certain market factors such as liquidity, slippage and commissions. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any portfolio will, or is likely to achieve profits or losses similar to those shown. All investments and trades carry risks.
No relevant positions.
