8/12/2019 RD1 Pontification on Legging Butterflies.doc - Cottle_
Charles
2/2
RD1 Pontification on Legging Butterflies from November 24,
2004
2004 Charles M Cottle 2 www.RiskDoctor.com
necessary for th is logic i s that a person who just wants a
butterfly or a condor because that is whatsuits hi m or her has
chosen that strategy owing to a little market analysis and that
research hasdictated that particular strategy. Only if the
temporary incomplete wingspread (just a naked long ora vertical) is
warranted or jus tified by that same analysis (there is more than
one way to sk in apotato (or do you say potato)) then and only then
can this person even think to leg. But rememberthis example because
trading is also about money management, conservation o f capital,
avoidingrosk of ruin, yada, yada, yada;
A guy is considering an OTM 5 point cal l but ter fl y for
around $1.00 where the bullspread is 2.50 and the bear spread is
1.50 and where the lowest stri ke call is $5.00,the middle strike
call is 2.50 and the highest call is 1.00.
Butterfly Price 1.00Vertical Prices 2.50 1.50Call Prices 5.00
2.50 1.00
+10 Low Strike -20Middle Strike +10High Strike
Does it make sense for this guy to leg the short calls or the
bear spread first if he is bullis? No.
Does it make sense for him to buy 10*$5.00 calls ($5000) when he
wishes to only risk$1000 (10 one dollar butterflies)?
No, but he can buy 2 of them so as to be at least represented in
the market with hi sopinion. That t would make for a lot of legging
and transaction costs.
How about 10 of the high strike calls? They are only 1.00 and
that would be placing his$1000 bet.Not really because that is pure
long premium wasting away and now he has to bereally right. His
hard work and analysis said Butterfly a totally different
beast.
Does it make sense to buy 10 call verticals for $2.50
($2500).Not unless he is definitely going to work the credit on the
other side soon(and getfilled even if slightly worse than
anticipated) because otherwise he has to drop itdown to 4 spreads
to keep it within the $1000 willing to be lost.
Well, as you can see there is a lot to consider with the
prospect of l egging or not .
