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Butterfly Strangle Strategy

The Butterfly Strangle is an options trading strategy that combines elements of both the traditional strangle and butterfly spreads. Here's a breakdown of the strategy:

Strategy Overview:
  • A traditional strangle, involves buying both a call and a put option with the same expiration date but different strike prices.

  • The primary goal of this strategy is to profit from a significant price move in the underlying asset, regardless of whether the move is up or down.

  • Instead of using a single options as you would with a traditional strangle, the Butterfly Strangle employs two out-of-the-money (OTM) butterfly spreads, one on the upside and one on the downside.

Components of the Strategy:
  • To implement a Butterfly Strangle, you would buy both a call butterfly on the upside such as ‘Pin High’ and a put butterfly on the downside such as ‘Pin Low’

  • The strategy requires a directional move in the underlying asset and ideally a closing price in one of the two profit zones. The closer the market closes to one of the short strike, the greater the reward at expiration.

How to Enter the Strategy:

There are two ways to enter the Butterfly Strangle:

  • Scaling In, entering one side at a time, gradually building the position.

  • Entering both butterflies at the same time, this is optimal if you prefer a more mechanical approach.

How to Exit the Strategy:

One common approach is to scale out of the position gradually. This can be done when either of the following conditions are met:

  • At 2x Premium, consider scaling out when your options' premium has doubled

  • Exit when the price of the underlying asset reaches the short strike price of your butterfly spread.

Scaling out of the position based on this criteria can enhance your success rate over time and help you manage your trades effectively.

Market Conditions:
  • The Butterfly Strangle is most effective in markets with relatively high implied volatility (IV), negative gamma and particularly useful during high volatility events, such as the FOMC where there is little to no directional edge.

  • The Butterfly Strangle strategy helps mitigate directional risk since it combines both call and put options.

  • It increases the likelihood of "pinning," as there are two potential pins.

  • This strategy can be suitable for traders who seek limited screen time or those who work a full-time job, as it doesn't require constant monitoring.

  • The main drawback of this strategy is the increased overall cost of the trade. By entering two butterfly spreads, you reduce the potential for reward and could lose on both spreads.

In summary, the Butterfly Strangle is a more simple options trading strategy that combines elements of strangles and butterfly spreads. It aims to reduce directional risk, increase the likelihood of pinning, and is particularly useful in high implied volatility scenarios. However, it comes with the trade-off of higher costs and potentially lower rewards compared to a more active approach. Traders should carefully consider their goals and risk tolerance before employing this strategy.

One of the members, Sanjeev, has conducted an experiment in which he bought all three pins at once. His report is attached below.

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