© 2012 Locke in Your Success, LLC. Butterfly Trading Strategies part 1 of 3, 2/4/12 John Locke Locke in Your Success, LLC. Know what you want, make it

© 2012 Locke in Your Success, LLC.© 2012 Locke in Your Success, LLC.

Butterfly Trading StrategiesButterfly Trading Strategiespart 1 of 3, 2/4/12part 1 of 3, 2/4/12

John LockeJohn LockeLocke in Your Success, Locke in Your Success,

LLC.LLC.Know what you want, make it happen!Know what you want, make it happen!

I teach traders how to improve their trading and I teach traders how to improve their trading and become more profitable!become more profitable!

www.lockeinyoursuccess.comwww.lockeinyoursuccess.com


DisclaimerDisclaimer

Any information contained in this presentation is for educational Any information contained in this presentation is for educational purposes ONLY. Neither Locke In Your Success, LLC, John Locke nor it’s purposes ONLY. Neither Locke In Your Success, LLC, John Locke nor it’s subsidiaries nor any of their respective officers, employees, subsidiaries nor any of their respective officers, employees, representatives, agents or independent contractors are, in such representatives, agents or independent contractors are, in such capacities, licensed financial advisors, registered investment advisors capacities, licensed financial advisors, registered investment advisors or registered broker dealers. Neither do they provide investment nor or registered broker dealers. Neither do they provide investment nor financial advice nor make investment recommendations, nor are they in financial advice nor make investment recommendations, nor are they in the business of transacting trades. Nothing in this communication the business of transacting trades. Nothing in this communication constitutes a solicitation, recommendation, promotion, endorsement or constitutes a solicitation, recommendation, promotion, endorsement or offer (buy or sell) by Locke In Your Success, LLC, or others described offer (buy or sell) by Locke In Your Success, LLC, or others described above, of any particular security, transaction or investment.above, of any particular security, transaction or investment.

* The risk of loss in trading securities, options, futures and forex can be * The risk of loss in trading securities, options, futures and forex can be substantial. Customers must consider all relevant risk factors, including substantial. Customers must consider all relevant risk factors, including their own personal financial situation, before trading. Options involve their own personal financial situation, before trading. Options involve risk and are not suitable for all investors. See the Options Disclosure risk and are not suitable for all investors. See the Options Disclosure

Document: Characteristics and Risks of Standardized Options, available Document: Characteristics and Risks of Standardized Options, available atat

www.lockeinyoursuccess.com


The “High Probability Iron The “High Probability Iron Condor”Condor”

Risk $9000 to make $900….YUCK!


The “Low Probability Iron The “Low Probability Iron Condor”Condor”

Risk $7300 to make $2700……Better


The “Very Low Prob The “Very Low Prob Condor” or the Condor” or the

“Butterfly”“Butterfly”

Risk $1500 to make $3600…. Yes!!

Butterfly ChallengeButterfly Challenge

Risk reward is great Risk reward is great

Range stinks Range stinks

How do I take a butterfly which How do I take a butterfly which has a great risk/reward ratio and has a great risk/reward ratio and give it the same range as the give it the same range as the “high probability iron condor”?“high probability iron condor”?


The AnswerThe Answer

Method 3 Butterfly late Method 3 Butterfly late 2007 (M3) 2007 (M3)

Method 9 Butterfly early Method 9 Butterfly early 2008 (Bearish Butterfly)2008 (Bearish Butterfly)


Since then….Since then….

The M3 and Bearish Butterfly have been The M3 and Bearish Butterfly have been traded through some of the most volatile traded through some of the most volatile markets in history!markets in history!

08 crash, 10 flash crash, 11 crash in Aug08 crash, 10 flash crash, 11 crash in Aug

Record rallies in 09, 10Record rallies in 09, 10

Made improvements along the way Made improvements along the way


M3 Trade SystemM3 Trade System

The M3 is a trade that has evolved into a system that I The M3 is a trade that has evolved into a system that I now use as a learning tool. now use as a learning tool.

The M3 allows traders to learn “proper” position analysis, The M3 allows traders to learn “proper” position analysis, position control and decision making processes while position control and decision making processes while trading a live position, experiencing live execution and trading a live position, experiencing live execution and maintaining relative safety in the market place.maintaining relative safety in the market place.

The M3 is designed to minimize risk or “not lose money”.The M3 is designed to minimize risk or “not lose money”.

It is not designed to create large monthly profitsIt is not designed to create large monthly profits..


M3 Trade SystemM3 Trade System

The M3 can be used as a stand alone trade The M3 can be used as a stand alone trade system. system.

As a stand alone system the M3 has As a stand alone system the M3 has historically produced an average of around historically produced an average of around 3-5% per month for most of my students. 3-5% per month for most of my students. However past performance can not predict However past performance can not predict future results.future results.

I still trade the M3!I still trade the M3!© 2012 Locke in Your Success, LLC.© 2012 Locke in Your Success, LLC.

Advantages of the M3Advantages of the M3


No searching for stocks.No searching for stocks. No need to pick direction.No need to pick direction. Can be entered regardless of market Can be entered regardless of market

conditionsconditions Most adjustments are not urgentMost adjustments are not urgent No need to sit in front of the computer all day No need to sit in front of the computer all day Can be in the market, making money from Can be in the market, making money from

anywhere in the world, in any time zone, anywhere in the world, in any time zone, even while on vacation.even while on vacation.

I can trade while I’m skiing.I can trade while I’m skiing.


I can trade while I’m at the I can trade while I’m at the lake.lake.


I can trade when I’m jumping I can trade when I’m jumping off buildings in Las Vegas.off buildings in Las Vegas.


I typically check this I typically check this trade once a daytrade once a day

Most of the time I don’t need to do Most of the time I don’t need to do anything.anything.

The times that I do need to do The times that I do need to do something, I can usually put it off.something, I can usually put it off.

Only in rare cases would I NEED to Only in rare cases would I NEED to jump in and do something right away.jump in and do something right away.


M3 does M3 does notnot have “hard” have “hard” guidelinesguidelines

Trading from a rule sheet does not teach you Trading from a rule sheet does not teach you to become a great trader.to become a great trader.

Knowing the concepts of trading as well as Knowing the concepts of trading as well as how, why and when to apply those concepts how, why and when to apply those concepts is teaches you to trade.is teaches you to trade.

The M3 uses concepts instead of a rule sheet.The M3 uses concepts instead of a rule sheet.


Underlying Concept of Underlying Concept of M3M3

Maintain positive Theta, relatively flat Delta, low Gamma Maintain positive Theta, relatively flat Delta, low Gamma and negative Vega.and negative Vega.

More important than the current Greeks are the Greek More important than the current Greeks are the Greek trends (what going to happen to the Greeks at any given trends (what going to happen to the Greeks at any given price point on the analyze graph, as time goes by) price point on the analyze graph, as time goes by)

Use a stock, or stock substitute, with a bearishly positioned Use a stock, or stock substitute, with a bearishly positioned options spread (butterfly) position.options spread (butterfly) position.

Assess risk daily by analyzing, the Greeks and the Greek Assess risk daily by analyzing, the Greeks and the Greek Trends and then adjust the position if needed.Trends and then adjust the position if needed.


Typical Entry PositionTypical Entry Position


Typical Entry PositionTypical Entry Position


ObjectObject

The object of the game is to keep The object of the game is to keep the proper balance between the the proper balance between the butterfly and the stock or stock butterfly and the stock or stock substitute while maintaining substitute while maintaining positive Theta, neutral Delta, low positive Theta, neutral Delta, low gamma and negative Vega but gamma and negative Vega but most important I want to maintain most important I want to maintain favorable Greek Trends in my area favorable Greek Trends in my area of concernof concern


Preferred PositioningPreferred Positioning


Underlying for examples is Underlying for examples is RUTRUT

RUT put butterflies with 50 point wingsRUT put butterflies with 50 point wings

Butterflies are hedged with either RUT calls, IWM calls Butterflies are hedged with either RUT calls, IWM calls or IWM stock. We will use RUT calls.or IWM stock. We will use RUT calls.

The ratio of the butterflies to stock will vary with The ratio of the butterflies to stock will vary with butterfly pricing (or implied volatility)butterfly pricing (or implied volatility)

M3 can be used with other indices and some stocks M3 can be used with other indices and some stocks but wing width and ratios may varybut wing width and ratios may vary


Entry Guidelines Entry Guidelines

Entry:Entry: Approximately 56 DTE Approximately 56 DTE

Butterfly Positioning:Butterfly Positioning: Short strikes 20 – 30 Short strikes 20 – 30 points below underlyingpoints below underlying

Longs:Longs: Purchase sufficient number of deep Purchase sufficient number of deep ITM long options (or stock) so the opening ITM long options (or stock) so the opening position is either flat Delta or leaning slightly position is either flat Delta or leaning slightly in the direction of your market opinionin the direction of your market opinion


““Planned Capital” IS a fixed number that we use to base our Planned Capital” IS a fixed number that we use to base our risk management numbers off of and is a reasonable risk management numbers off of and is a reasonable representation of the maximum amount of capital we are representation of the maximum amount of capital we are likely to have in the trade during an average month.likely to have in the trade during an average month.

Trades with varying capital cannot be properly managed Trades with varying capital cannot be properly managed with profits and losses based off of a percentage of with profits and losses based off of a percentage of “whatever is in the trade” because these trades almost “whatever is in the trade” because these trades almost always have substantially more money in them when they always have substantially more money in them when they win lose than they do when they win.win lose than they do when they win.

““Planned Capital” IS NOT the maximum amount allowed in Planned Capital” IS NOT the maximum amount allowed in the trade.the trade.

In low volatility months with large price moves or if trading In low volatility months with large price moves or if trading into expiration, your capital may substantially exceed the into expiration, your capital may substantially exceed the planned amount.planned amount.

Planned CapitalPlanned Capital


Risk ManagementRisk Management

Planned Capital:Planned Capital: $5,000 - $ 8750 per IWM call $5,000 - $ 8750 per IWM call depending on butterfly/call ratio which will depending on butterfly/call ratio which will vary with market conditions and underlying/s vary with market conditions and underlying/s you are usingyou are using

Target Profit:Target Profit: +10% of planned capital +10% of planned capital

Max Loss:Max Loss: -10% of planned capital -10% of planned capital


AdjustmentsAdjustments

We are going to use a combination We are going to use a combination of techniques including verticals, of techniques including verticals, varying butterfly to call ratios and varying butterfly to call ratios and moving the butterflies to maintain moving the butterflies to maintain desirable Greeks and Greek trends desirable Greeks and Greek trends while maintaining a reasonable while maintaining a reasonable amount of capital in the trade.amount of capital in the trade.


Desired GreeksDesired Greeks

Desired Greeks will vary depending on position size, Desired Greeks will vary depending on position size, the trend of the Greek we are looking at and the the trend of the Greek we are looking at and the direction of movement we are concerned about. direction of movement we are concerned about.

Greek management is based off of position size.Greek management is based off of position size.

Position size is determined from how many IWM calls Position size is determined from how many IWM calls the position has. (1 RUT call = 10 IWM calls)the position has. (1 RUT call = 10 IWM calls)

For today position size will be 1 RUT call (10 IWM calls)For today position size will be 1 RUT call (10 IWM calls)


““In General”In General”The desired Greeks for the position The desired Greeks for the position

size of 1 RUT call are…size of 1 RUT call are…

Delta: Ideally +/- 50 Delta: Ideally +/- 50

Acceptable +50 to (-)100Acceptable +50 to (-)100

Delta may exceed this range Delta may exceed this range with favorable Gamma trendwith favorable Gamma trend


In GeneralIn General

Gamma: (+) is good / (-) is badGamma: (+) is good / (-) is bad

Unfortunately negative Gamma is a byproduct of Unfortunately negative Gamma is a byproduct of Theta (unless we are naked options which we are Theta (unless we are naked options which we are not)not)

The total Gamma number, however, is not as The total Gamma number, however, is not as important as the trend of Gamma. As long as Delta important as the trend of Gamma. As long as Delta is under control and Gamma is trending positive in is under control and Gamma is trending positive in the direction of concern at a favorable rate, there is the direction of concern at a favorable rate, there is no problem. Gamma trend can be observed with no problem. Gamma trend can be observed with the analyze graph.the analyze graph.


Theta and VegaTheta and Vega

Theta: Positive!!! More is better!!!Theta: Positive!!! More is better!!! BUT, more Theta is better ONLY if Gamma and BUT, more Theta is better ONLY if Gamma and

Gamma trend are under control. There are times it is Gamma trend are under control. There are times it is favorable to reduce Theta to mitigate Gamma risk.favorable to reduce Theta to mitigate Gamma risk.

Vega: This trade should maintain negative Vega…How Vega: This trade should maintain negative Vega…How much?much?

When IV is high, especially under conditions when the When IV is high, especially under conditions when the price is likely to stabilize, then we want more negative price is likely to stabilize, then we want more negative VegaVega

When IV is low especially when the price is very over When IV is low especially when the price is very over bought, we want “less negative” Vegabought, we want “less negative” Vega


Documents

© 2012 Locke in Your Success, LLC. Butterfly Trading Strategies part 1 of 3, 2/4/12 John Locke Locke in Your Success, LLC. Know what you want, make it