9 Weeks to Better Options Trading: Butterfly Spreads
Veteran options trader Steve Smith breaks down a key strategy.
For the first article in the series, click here.
If you are a novice options trader, we suggest you start with Steve Smith's 6-Week Options Trading Kickstarter series.
Do not touch nothing. The truth will be revealed by the facts as they exist.
-- Hercule Poirot's in The Murder on the Orient Express
One of the biggest challenges in using options as an investment tool is that not only must you be right on direction and price target, but you must also be accurate in your timing. You can buy a call with too short an expiration period, watch the stock go up, and actually lose money because time decay will offset most or all of the directional gains if the move does not come quickly enough.
Butterfly spreads are a good, low-cost way to establish positions that are not impacted by time decay or short-term price movement. Due to their balanced construction, their value only becomes price sensitive -- albeit exponentially so -- as expiration approaches.
In this way, one can eliminate the need to be right about the velocity of the price move -- you need only be correct about the price level at expiration. This makes butterfly spreads useful as both protective positions and potentially highly profitable directional bets.
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