Butterfly Options Strategy Works As Market Loses


Simpler Trading Team

5 min read

The Wall Street loss of value was swift, continuous, and deep as inflation numbers sent the stock market gapping down Tuesday.

This market environment created a chaotic atmosphere for traders trying to identify potential trades. Many justifiably sat on the sidelines while others worked through the chaos to find the moves at hand.

One of Simpler’s traders shared how a butterfly options strategy has been working all year no matter how the market reacts to economic news – good or bad.

Options with Kody Ashmore
Futures with Raghee Horner

Inflation data sends market gapping down

Traders were expecting a volatile market pending the release of the latest U.S. Consumer Price Index (CPI) numbers early Tuesday morning before the stock market opened.

The data didn’t disappoint those looking for a deep gap down.

In the market today, the Dow crumbled to 31,104.97 points to fall 3.94% (dropping 1,276.37 points on the day). The Nasdaq fell drastically to 11,633.57 points for a 5.16% loss while the S&P 500 gapped down 4.32% to 3,932.69 points.

Every trader should have expected some kind of market twist today, but how many were prepared to trade the chaos?

Allison Ostrander, Director of Risk Tolerance at Simpler Trading, awaited the news with an options trading plan in hand. She has a strategy that has been working all year in shifty market conditions.

She has regularly turned to a compound butterfly options strategy designed to limit risk and boost the risk vs. reward ratio in her trade setups.

Specifically, she identifies a potential trade where she can apply a broken wing debit butterfly options strategy with one leg on the call side and one on the put side.

“It’s a great way to use a combination of different butterflies to take advantage of the market environment you might be in,” Allison said. “Because of that uncertainty creeping in with Fed (Federal Reserve), CPI, and other data, the market has really been focused on these events this year and it’s been a very volatile year.”

Allison focuses on limiting capital risk to get a good probability of profit, a better risk vs. reward ratio, or combination of both in her trade setups.

In a market with constant possibilities of sharp spikes up or deep gaps down – sometimes in the same day – that are often influenced by news events, Allison wants to be prepared for any type of move.

This market is one where even seasoned traders can miscalculate market expectations. On Monday, the fourth consecutive day of higher prices in the indexes, traders were anticipating a possible move higher today based on the market already “digesting” any bad inflation numbers. The market subsequently puked and sent the indexes spiraling down.

The broken wing debit butterfly options strategy allows Allison to work through moves on both sides of the market. The idea behind this trade setup is that no matter how the market shifts, the profit to the opposite side can offset losses or capital outlay.

“It is a great way to take advantage of the volatility without necessarily having to be correct on the direction of the move,” Allison said. There is only one thing we can be certain of – how much capital risk we put out there.”

“This is a great strategy that I’ve been using this year and I think it’s a good one to take advantage of this week,” said Allison, who has been applying the options strategy regularly on the S&P 500 (SPX). She explained a specific broken wing debit butterfly setup in a free video available for viewing.

Unique trading style ‘recycles’ profits

In this market, traders are often seeking more insight for identifying potential trade setups.

“What type of trader will you be?” is a common question asked of Allison. Trading style is often determined by the time available to the trader and personality type or preference, as well as risk tolerance.

Identifying profit potential in an uncertain market can come in the form of a mentor who knows how to “recycle” gains, even in volatility.

Learn more about Allison’s trading strategy, and gain access to live-trading sessions, real-time stock alerts, and how a professional taps into a wild market.

Limiting trade risk while targeting gains

The broken wing debit butterfly options strategy requires some learning and understanding of how butterfly options trading setups can be used in varying market conditions.

By definition, the butterfly options strategy is a neutral, multi-leg setup that combines bullish and bearish spreads. Butterfly setups generally require less premium at risk. A butterfly setup can cost less than half of a long call option on the same underlying stock.

Essentially a butterfly spread is the combination of two vertical spreads. Butterfly prices can fluctuate throughout the trade because there are three legs to the trade.
A positive to the butterfly spread is that the maximum loss is what was paid for the options contract. Butterfly options trades are designed to gain the most value as the contract moves closer to the expiration date.

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