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Stocks & Commodities V. 32:2 (22-26): The Weekly Options, Part 2 by John A. Sarkett

To Adjust Or Not To Adjust

The Weekly Options

Part 2

Last month in part 1, we tracked the growth in weekly op- butterfly) on Thursday (eight days to expiration) and Monday
JOSE CRUZ

tions and presented one traders success story trading AAPL (four days to expiration). The risk curve of an AAPL iron
iron butterflies. Here, we look at three more ways to trade butterfly is displayed in Figure 1. Currently, he favors the
weeklys. four-day trade because the increased volatility of late in AAPL
made holding the longer trade riskier. He puts on his trade

S
by John A. Sarkett at-the-money with 20 wide wings, similar to what Tulauskas
does (although the width will sometimes vary depending on
heridan Options Mentoring (SOM) community member the implied volatility of the at-the-money options). His normal
Leo Andrade trades Apple (AAPL) weeklys but in a iron butterfly has 30 contracts.
somewhat different manner from fellow SOM community He aims to collect between $8 and $11 credit, depending
member Ed Tulauskas, whom I profiled in part 1. on the then-implied volatility. If the initial spread has too
Andrade puts on his weekly Apple (AAPL) trade (an iron much negative delta, he may add insurance in the form of
Copyright Technical Analysis Inc.
Stocks & Commodities V. 32:2 (22-26): The Weekly Options, Part 2 by John A. Sarkett
OPTIONS

an at-the-money call in the Risk Profile Price Chart Movement Analysis Statistics & Fundamentals
next expiration. However,
he prefers to go into the Volatility Adjust 0 Projection Thu 28 June 2012
next trading day slightly 778%
-7.7% -6.0% -4.3% -2.5% -1.1% 1.0% 2.7% 4.4% 6.2%
28,000
short delta. He does a fire

582.74
568.32
668.02

590.85
-102.00 Realized P/L
drill (a phrase that SOM 722% +30 Jul 585 Call 31.99 26,000
+30 Jul 565 Put -44.78
founder Dan Sheridan 667% -30 Jul 575 Call 43.48 24,000
coined for a process he -30 Jul 575 Put -56.65
uses) in the last half hour 611% 22,000

of each day, analyzing 556% 20,000

possible outcomes for
tomorrows open, and tak- 500% 18,000

ing appropriate defensive 444% 16,000

steps. For example, he
389% 14,000
may buy one or more next-
expiration at-the-money 333% 12,000
puts to keep his delta 278% 10,000
slightly negative, that is,

OptionNet Explorer, Sheridan Options Mentoring

he leans into the pain 222% 8,000
the negative vega. 167% 6,000
Andrade primarily uses
next-expiration puts and 111% 4,000

calls to control the delta 66% 2,000

of the trade. He will,
however, adjust delta -8% -279

hesitantly since the price -56% -2000

of AAPL has a tendency -111% 7/20/2012 (0) -4000

583..61
to whipsaw. Since he
566.32

6/28/2012 (22) 49.1%% 17.6% 33.4%%

works from home, he is -167% -6000
530 540 550 560 568.35 580 590 600 610
able to watch his trading
screen while the market is Figure 1: risk curve of a skinnier (10-point strikes vs. 20) aapl iron butterfly. A robust structure, it would
take a fairly large move to generate significant losses.
open, so he uses judgment
and experience instead of
mechanical triggers to make adjustments to the original trade. n It involves an interim loss (although offset to some
He does set alerts at halfway between the short strikes and the extent by the unrealized profit in the put spread)
breakeven points but doesnt necessarily make adjustments and will require Andrade to stay in the trade longer
when those points are reached. to realize his target profit.
Lets say Apple does move higher. How does Andrade ad-
just? Initially, he prefers to buy a next-expiration call or calls Andrade says, Trading weeklys means one has potentially
to cut the delta at least in half. If the move up is particularly 52 profit opportunities. If one has a losing trade, there are many
aggressive, especially if its an opening gap, he may buy in more opportunities to make up that loss than would be the case
some or all of his short calls. When he senses AAPL has run if there was a loss on a monthly or longer-dated trade.
its course or if it retraces, he will reestablish the call spread The option game is ever-evolving, and Andrade evolves with
in the iron butterfly at the same or higher strikes. it: new ideas, new strategies, and new tactics. For example,
If AAPL approaches his upper breakeven early in the trade recently hes been experimenting with a slightly longer trade,
for example, Monday or Tuesday he may roll up his call starting on a Wednesday or Thursday, with expiration in the
spread three or four strikes, converting the trade into an iron following week. He uses the same strategy, that is, an iron
condor (a common adjustment at SOM for many butterfly trad- butterfly, but the twist here is that he puts on only half the
ers). This adjustment gives a wider range for AAPL to move number of options he would normally place. He plans also
through and still stay within the trades expiration breakeven to increase the size of the trade on the following Monday
points. The drawbacks of this adjustment are: and place the new options either at the same strikes as origi-
nally, or at higher or lower strikes to reflect the current price
n It requires more capital
of the underlying. This is a slightly more flexible structure.
n It reduces maximum profit potential (unless more The drawback? It does expose him to price movement over
contracts are added) the weekend.

Copyright Technical Analysis Inc.

Stocks & Commodities V. 32:2 (22-26): The Weekly Options, Part 2 by John A. Sarkett
OPTIONS
Why AAPL?
Andrade says: AAPL options may be the most
actively traded options of any stripe: equity,
index, or exchange traded fund (ETF), so they
have great liquidity with consequently tight
bid/ask spreads. There are times when AAPL
is running that I might want to buy or sell
options to stop the bleeding. With AAPL I can
put in a market order, which has to be filled
knowing I wont see much slippage. While I
dont like to buy or sell spreads at the market,
if thats necessary to do, AAPL is the only
underlying I would be comfortable with.
But weeklys arent free money, Andrade is quick to point out:
The biggest disadvantage to weeklys is the price risk. Delta/
gamma can be treacherous if the underlying starts trending ag-
gressively. This is mitigated somewhat by faster theta, that is,
options decay, benefiting the short sides of the strategy. Thats
where we earn our profits in timely adjustments.
Like Tulauskas, Andrade has a winning trading record.
My goal is to realize 2 1/2% to 5% a week on the capital
committed to the trade (not necessarily the funds exposed to
the trade, since I always have at least 30% or more in reserve
for contingencies), Andrade says. So far, Ive been able to
stay within those parameters.
Nine-day calendar
A favorite of active trader and SOM mentor Jay Bailey is
the nine-day weekly calendar, which has been getting atten-
tion. Its been available since October 2012. The benefits:
Some 40% of these require no adjustments, and 30% just
one. Best of all, it offers four times the potential yield of the
monthly calendar.
There is a tradeoff: Weeklys make you more vulnerable to
I thought Id dare to explore this margin
call just to see what happens!
Copyright Technical Analysis Inc.
large underlying moves, which can take you out of the trade
since there is less time to recoup. (A trader could buy pro-
tective options to reduce the risk, but that flattens the profit
curve). Many weekly traders aim to be out in two to three
days, eliminating the trade risk entirely; when you have no
position, you cant lose.
Heres how it works: Using the Russell 2000 Index (RUT)
as the underlying, put on a short weekly vs. a long monthly
on the Tuesday or Wednesday nine or so days before the
weekly expiration. Target profit: 12%, maximum loss al-
lowed: 15%.
Adjustment 1: When the underlying moves to within
15% of the expiration breakeven, to get
delta neutral, add another calendar in
the direction of the move.
Adjustment 2: If the underlying moves to the strike
of either calendar, take off the calendar
farthest from the money and re-center
at-the-money.
Adjustment 3: If the underlying again moves to within
15% of the breakeven on the newly
centered calendar, exit the trade.
No matter what, on the Wednesday before expiration, exit.
There is too much gamma at the tail end of the trade.
On the profit side, Bailey puts in a contingency order to
sell when profit hits 10%, which often happens early in the
trade.
What about trading across special-situation Fridays, for
example, when the monthly employment report comes out?
Is that a good or bad idea? Bailey backtested seven months
and found a rather counterintuitive result: five winners, one
breakeven, and one loser. So the strategy appears hardy.
Trading the SPX
Dot Hazlin, of Mystic, CT, is a trader of S&P 500 index (SPX)
iron butterflies, with one and a half years of experience under
her belt and profitable experience, at that.
She applies SOM tactics to the SPX fly strategy 30 wide, for
example, 1620/1650/1680, short the 1650 puts & calls, long
the 1620 put, and long the 1680 call. Her risk-management
strategy is straightforward: When the market moves 10 points
either way from the initiation point, she simply rolls out the bad
side to farther strikes, typically 30 points beyond the original
A trader must either be out
of the trade two to three
days before expiration or
take protective steps.
Stocks & Commodities V. 32:2 (22-26): The Weekly Options, Part 2 by John A. Sarkett
Risk Profile Price Chart Movement Analysis Statistics & Fundamentals

Volatility Adjust 0 1,628.12 Projection Thu 09 May 2013

--3.2% -2.6% -2.0% -1.4% -0.8% -0.3% 0.4% 1.1% 1.7% 2.3%
53% 16,000

1641.55

1650.42
1614.95

1620.62
-40 Realized P/L
47% +10 May 1665 Call 6.18 14,000
+10 May 1605 Put -20.83
-10 May 1636 Call 38.21
40% -10 May 1635 Put -60.68 12,000
+10 May 1635 Call 38.21
33% -10 May 1665 Call 6.18 10,000
-10 May 1655 Call 10.48
+10 May 1675 Call 3.32
27% 8,000

20% 6,000

13% 4,000

7% 2,000
5% Profit Target 1,500

-1% -345

-7% -2,000
-10% Max Loss -3,000
-13% -4,000

-20% -6,000

-27% -8,000

-33% -10,000

-40% -12,000

-47% -14,000

-53% -16,000

-60% -18,000

-67% -20,000

1665.54
1624.50

5/17/2013 (0)
5/9/2013 (8) 44.3% 48.9% 6.7%
-73% -22,000
1580 1590 1600 1610 1620 1628.12 1640 1650 1660 1670
-56% -48% -38% -25% -11% -2%
PnL -16673 -14415 -11259 -7393 -3313 -345 -471 PnL
-1% 2638 3077 1894%
8% 10% 6%
Theta -441.56 -516.03 -485.17 -321.02 -52.19 183.32 -43.84 Theta
416.27 412.73 226.86

Figure 2: adjusting an iron butterfly. Here you see a risk curve of how Dot Hazlin would adjust an SPX iron butterfly by converting it to a condor. If the SPX
moved higher, she would buy in the bad side and sell a call spread farther out, giving her a wider, but somewhat lower, profit band.

put-call short strikes. The risk curve would then change from example, adding puts and/or calls to dampen the risk in the
butterfly shape to the iron condor (Figure 2). trade. Nearly always, this will cost and will flatten the profit
In most weeks, no further adjustments were needed. Not curve, so he strongly suggests the early exit, by and large.
bad. It has worked for her. Over the past 18 months, Hazlin It makes life simpler, the veteran of 22 years in the CBOE
enjoyed a long string of winners, but the relentless up move pits and many ups and downs of his own in the markets, says.
in the spring of 2013 catalyzed a four-week string of losers. Simple is good.
It was challenging psychologically, she says. One was a
maximum loss of one and one-half times expected returns. A regular contributor to this publication
This put a dent in the 19 weeks of average 3.5% returns. since 1995, John A. Sarkett is the author
Losing isnt easy, but she came back at half size to rebuild of Option Wizards: Real-Life Success Sto-
confidence and is progressing again. I have been working ries From The Financial Markets, (http://
in test kitchen mode, testing alternative trade manage- option-wizard.com). Dan Sheridan can be
ment, incorporating the use of long options both at the trade reached at dan@sheridanmentoring.com
inception and as a method of adjustment. She continues to or via www.sheridanmentoring.com.
test new ideas and tweak, saying after the turmoil is over in
Washington, DC regarding debt ceilings, healthcare, and so Further reading
on, she will return to full-size positions. Sarkett, JohnA. [2014]. The Weekly Options,
Meanwhile, Sheridan notes: Its not all free money here in Part 1, Technical Analysis of Stocks &
the world of weeklys, not by any means. He points out that as Commodities, Volume 32: January.
the weekly series get closer to expiration, delta and gamma
Sheridan Options Mentoring,
(change and acceleration of change) increase exponentially.
OptionNet Explorer
This is why a trader must either be out of the trade two to
three days before expiration or take protective steps, for
Copyright Technical Analysis Inc.
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