# Playing Over-hot Underlyings with the Call Butterfly

A call butterfly is a fully hedged options trade …

… with an upwards bias.

It consists of four call options.

…and 2 sells.

One can play any overtly rising underlying with the call butterfly, without batting an eyelid.

Why?

Firstly, and most importantly, one is fully hedged.

Meaning?

At first look, the call butterfly seems market neutral as far as basic mathematics is concerned, that is +1, -2, +1, net net 0.

So, net net, one isn’t looking at a large loss if one is wrong.

When is one wrong here?

If the underlying doesn’t move, or if it falls, in the stipulated period, then one is wrong,…

…and one will incur a loss.

However, the loss will be relatively small, because of the call butterfly’s structural market neutrality.

And that’s magic, at least to my ears.

Method to enter anything flying off the handle with the chance of a small loss?

Will take it.

Then, also very importantly, the margin requirement is relatively less, when one uses the following chronology.

Then come the sells.

Upon the upholding of this chronology, the market regulator is lenient with one on margin requirement, as long as the trade-construct is market neutral.

Typically, for one butterfly, total margin requirement is in the range of 50 to a 100k.

Now let’s talk about what one is looking to make.

5k per single-lot trade-construct, if it’s fast, as in execute today, square-off tomorrow, or even intraday, if expiry is close.

10k if slow, as in 7 to 10 days.

If the butterfly is not yielding because the underlying is not moving, then one is looking to exit, typically with a minus of under 3k.

Just do the math. Numbers are great.

What kind of a maximum loss are we looking at, if things go badly wrong, as in if the underlying sinks?

5k to 10k.

Can the loss be more?

If the trade construct is such that the butterfly can even give 40 odd k till expiry, one could even be looking at a max loss of about 15k too.

Here’s an example of a call butterfly trade that can lose around 15-16k, but has the potential to make upto around 45k till expiry. The graphical representation is courtesy Sensibull.

I mean, it’s all still acceptable.

Tweaks?

Let’s say one is losing.

Sells will be in biggish plus.

Square-off the sells. Yeah, break the hedge.

They are losing big.

With some time to go till expiry, if the underlying goes back up, the buys gain.

What one makes off the trade is proportional to how much the underlying goes up.

It’s riskier. Correspondingly, profit potential is higher.

Money risked here will be up to double of the fully hedged version of the trade, and one could lose this amount if the underlying does not come back up appropriately and in time. Pocketed premium of the squared-off sells softens the hit.

Therefore, it makes more sense to pull this tweak with at least ten days to go before expiry, giving the underlying time to recoup.

Got another tweak.

Underlying’s on a roll, and you want to make the most possible off the opportunity.

Square-off the sells at a huge loss.

Let the buys, which are winning big, run for some part of the day.

Chances of them yielding more are very high.

If the underlying promises to close on a high, square-off the out-of-the-money buy before close of trade, and take the in-the-money buy overnight.

Risky, though.

You could lessen your risk, and increase your chances of taking most profits off the table by squaring off the in-the-money buy and taking the out-of-the-money buy overnight.

Square-off the overnight buy next morning on a high, or wherever feasible.

With this particular tweak, the trade becomes somewhat more like a lesser exposed futures transaction, at least for some time, after the hedge is broken.

There’s another thing one can do with the call butterfly.

One can adjust it as per the level of perceived bullishness.

If -1 and -1 are set at the same level, one trades for averagely perceived bullishness.

If one -1 is closer to the lower +1, and the other -1 is above this first -1, then one trades for below average perceived bullishness.

If one -1 is closer to the upper +1, and the other -1 is below this first -1, then one trades for above average perceived bullishness.

Anything else worth mentioning?

Volume. Need it.

Scaling up needs to correspond to one’s risk-profile, requirement, temperament and acumen.

One can make it an income thing by scaling up, during bull runs, or generally, just in case an up move is tending to pan out.

One can make the call butterfly do a lot of things.

It’s a very versatile trade to play a rising market, with low risk and low capital requirement.

🙂

# What is it about Vacuums?

I borrow often.

Shocked?

You won’t be, after you hear my borrowing ideology.

You see, I only borrow against a solid structure I’ve already created. Free and idle cash makes me take grossly irresponsible and wrong decisions with itself. I’ve learnt to first bind my free and idle cash in a structure, and then to borrow against this structure to create another new and ultimately free-standing structure. I’ve been amazed at the quality of investment decisions coming through for me with this methodology.

Also, I try to only borrow for the purpose of creating this new (solid) structure. Because I’m creating this new structure with borrowed money, this makes me work that much harder during due diligence.

Furthermore, I borrow to create vacuum.

As you understand already, vacuum attracts flow.

On top of that, and this is the icing on the cake, when I’ve borrowed, there’s pressure on me to save, and to nullify the borrowing as soon as I possibly can. Believe it or not, this fact, coupled with the principle of attracted flow, leads to the borrowed amount being filled up (paid back) very, very fast indeed.

What I then have left standing is my original solid structure.

Oh, yeah, I also have my new structure, which I have just created, and which will serve me.

So worth it.

# Shooting Straight, Shooting Right – Finding One’s Structures.

What are the right shots?

Who calls them?

Who doesn’t call them?

How many wrong shots? Before a right shot?

Why this discussion?

Yeah, I ask a lot of questions. I’ve become oblivious to the pain connected to the world finding out my exact level of silliness.

Yeah, I don’t keep my silliness under wraps. I’M NOT EMBARRASSED ABOUT MY SILLINESS. If you are, about yours, you are doing something grossly… WRONG. You are going to have huge problems finding what works for you. Reason – you’re not getting it out of your system – oh it’s so embarrassing, oh it looks so silly, oh it’s awkward…well stay where you are then, NOBODY is sorry for you.

I’m silly, them a little more, then maximum, till I’m not silly anymore, for a while. That’s when right shots happen.

Life is about taking pot-shots at something or the other. Yeah, ultimately, it boils down to that. You take a shot – at something. If you don’t, you are just left twiddling your thumbs, and life passes you by.

Once, me and my brother were fighting. We were kids. My grandfather heard the commotion, and stopped us. He just had one thing to say – and he said so much with that one sentence. He said that 100 years – they just pass you by in a flash. So stop fighting. Try and enjoy your togetherness. Whoaahhhh!!!

We’re not going to let life pass us by just like that. We’re going to first call the right shots, and then take them.

Right shots don’t just happen.

Before something fits, many things don’t.

You just have to keep on taking shots.

Forget about disappointment, embarrassment, awkwardness, silliness, what have you.

Keep on taking…shots.

On and on.

Something will fit.

Wait for it.

It feels right.

Build up on it. Copiously.

You’ve been groping in the dark, and have found something that works for you. Don’t let it go. Build on it. Till you can’t anymore. Let the structure stand. Let the structure be there for you, forever.

Then, look for your next structure.

# IUCS – Investing Under Controlled Stress

Let’s assume there are funds waiting to be invested.

In what form do you keep them?

Free?

Bound?

What?

Investors have the luxury of time. Traders don’t.

I’m really telling you, an investor’s funds need not be kept in free form.

Traders need to pounce, not investors.

If you don’t need to pounce, don’t keep your funds in free form.

Keep them bound. Semi-bound. Let’s call it stressed. Keep them stressed. Stress that is under your control.

Free funds are open to whims and fancies.

Whose?

Yours. Your bankers’. Anyone’s, who has an eye on the funds.

Plush with free funds, you take liberties. Your defences are down. You are liable to make mistakes, perhaps big ones.

Bound funds, on the other hand, are subject to activation barriers before release.

You think twice before releasing them, or perhaps thrice, if the locking is tight. You win precious time. During the extra time, you can well scrap an investment with a faulty premise, or you can discover hidden agendas or angles which cause you not to follow through. You get saved because of controlled stress.

Furthermore, bound funds don’t reflect on your banker’s system as funds waiting to be invested. He or she won’t bother you or incite you to make a mistake. You’ve knocked him or her out of the equation. Bravo!

Controlled stress can be of different degrees. When funds are irreversibly locked-in, then we cannot talk of control anymore. Anything below that is under our control with varying levels of effectivity. The stronger the (reversible) lock-in, the harder you’ll think about the new investment, because the activation barrier for making funds free again to invest is large.

Let’s not get too carried away. We can just make simple fixed deposits. These are completely within our control. You can break them with a letter to the bank manager. The activation barrier to free them is relatively small. However, you do think twice before freeing them. The’ve disappeared from your banker’s horizon. They’ve also disappeared from any online fraudster’s horizon, who was perhaps looking to clean you out.

Also, actually, you don’t really need to break these fixed deposits to get into a new investment, since breaking goes with a small interest-penalty. If you’ve got fresh funds coming in at a later date, but wish to invest now, you can borrow against a fixed deposit. This will again make you stop and think, because borrowing comes with a cost, i.e. interest. You will only get into the fresh investment if you really, really have to / want to. You will discard any half-baked investment idea. It’s still worth it, despite the interest. You might find this a bit crazy, bit I like to do it like this. For me, the biggest win here is that I am not breaking a former structure. Add to this the extra safety. Plus the extra thinking-time to ward-off bad investments. Add everything up, and you might also think that the borrowing cost is peanuts when compared to the benefits. Don’t forget, since you’ve got fresh funds coming in soon, you’ll soon be releasing the fixed deposits you are borrowing against from their overdraft mode. This is a meta-game strategy.

Yeah, keep investible funds in fixed deposits. It is really as simple as that.

The best things in life are really very simple.

Complication and sophistication are facades used by humans to hide their mediocrity.

A successful person does not need to hide his or her simplicity.

Simplicity is one of the biggest precursors to mega-success.

# Cross-Section Through a Performing System

You’ve struggled, as a result of which you’ve developed a system.

This is your system. it is invaluable to your market play. It performs.

A structure takes something to emerge. It doesn’t come for free. You need to pay for it with sweat, losses and tears. Once it emerges, it is yours to incorporate.

You know its value. You’re not going to let it go… …unless a better structure emerges, which makes its predecessor obsolete.

Normally, it doesn’t come to that. Structures don’t become obsolete just like that, and hence, you rarely let a structure go once it has emerged.

What you do is the following. You incorporate the new structure into your system by fine-tuning old and new, making them work in tandem.

Your system has become richer by one structure, although the combination of old and new outdoes 1 + 1 = 2 easily.

Sometimes, a new structure starts to emerge, and blinds you. You want to plunge in. You want to raise the required funds by sacrificing your existing and lucrative structures. Happens sometimes.

DON’T.

Yeah.

If the lure of the new structure is so great, well, then borrow if you have to against your old structures, but for heavens sake don’t sacrifice them.

Squeeze your old structure till it coughs, but don’t kill it.

Because you’ve squeezed it by borrowing against it to finance the implementation of your fancied new structure, well, you’ve been able to then implement this fancied new structure.

Fine.

You’ve got what you wanted.

Now loosen the stranglehold upon your older structure to prevent it from dying.

Yeah, bring it back. Revive it. Pay back what you borrowed against it from your ongoing cash-flow, till the complete debt is nullified, so that your old structure breathes easy again and resumes yielding you money.

Voilà – now you have two structures adding to your income, presuming that the newer structure that emerged was ripe enough at birth to start yielding income immediately.

That’s how you do it.

# Hanging On to a Structure

How does one build a wall?

Brick upon brick, right?

One doesn’t usually take out the brick two layers below to use elsewhere. Common-sense.

Why should it be any different while building a rock-solid portfolio?

Well, it’s not.

Those who feel it is will soon realise… that it’s not.

You set up an investment.

You then see it through to its logical conclusion.

You don’t let it go in between… …unless we’re talking about a life and death situation.

Apart from this one caveat, you just don’t let the investment go. You see it through… to its logical conclusion. Period.

Meanwhile, other opportunities arise.

You are tempted to get into them. That’s what opportunities are for.

Now you need to be creative.

You’re not letting one structure go for the sake of creating another.

You are going to keep the former and create the latter.

How?

How were the reserves created?

They were created by former structures that were seen through to their logical conclusion. These contributed along their paths and upon their culmination.

Reserves not enough?

Borrow agains a former structure.

Don’t borrow big. Borrowed amount should not be big enough to harm the former structure, but big enough to couple with your reserves and see your new structure through.

Still not enough? Requirement for new structure not being met?

Let the new structure go.

Opportunities keep coming and going. No one’s got a copyright on opportunities.

Save up for the next one.

Brick by brick, remember. Without sacrificing the bricks below.

🙂

# Finding Structure Within

You are you. He is he. She is she. I am I. It is it.

Even if the above is the only thing that you carry home from this space, you’re done already.

Move on then, with your life, because you’ve understood something big.

You are not I. I am not you. He is not she. She is not he. That’s it.

Here’s the next biggie.

Those who come into funds need to know how to manage them. Period.

Do what you want. Run umpteen miles. Put up a million facades. Muster up all the drama you’re capable of. After that you’ll come to this conclusion …

… that nobody else is more capable of managing your funds than you yourself.

Why?

Because you are you. You know yourself best. A third party is firstly (realistically) not bothered about knowing you, and secondly is only capable of seeping into a minuscule portion of you, if he or she makes the effort. Forget about third parties.

So you realize you need to manage your own funds, what then?

Jump into the water.

While your corpus is small, make mistakes. Learn from them. That’s college. Tuition fees.

Recognize your strengths. Play to them. Pulverize your weaknesses after identifying them.

Then come the structures, from within. These are your structures. They’ll come from inside of you.

There’s you, and there’s the battle-field. The two are face to face. It’s a do or die situation. You go into reflex-action mode. Your systems start to function at full capacity. That’s when structures emerge.

Yeah, structures need an activation barrier to emerge.

There’s a protective structure. It’s your protective structure. It guides you to build your moat. It protects your family.

Then there’s your post-protection bulk-game structure. It guides you towards building up your innings without the worries of basic bread and butter.

Lastly, there’s your multiplication structure. It chalks out high-reward-high-risk strategies, tweaks them towards maximum possible safety, and tells you where to put that minute percentage of your corpus with the intent of achieving extra-ordinary gains.

Allow such structures to emerge. Embrace them. Innovate. Improvise. Achieve. Educate.

Go for the jugular.

# This is Getting Murky

Have you actually seen China’s account books?

Has anyone, for that matter?

How does the US pay for its imports from China?

With treasury-note IOUs?

Are Chinese GDP numbers doctored?

If yes, for how many years have the Chinese cooked their books?

How many more bailouts is Greece going to require?

Isn’t the amount of financial maneuvering increasing from bailout to bailout?

It feels as if real debt is being made to “go away” synthetically.

Things are getting murky in the financial world.

When that happens, the stage is set for tricky synthetic products to be offered.

It’s time to go on high alert.

You see, for the longest time, banks in the “developed” world have not been clocking actual business growth. However, their balance sheets are growing on the basis of trading profits. In almost all cases, the “float” is not increasing significantly from clients’ savings, or from new business. Instead it is increasing from good trading.

However, trading can go wrong for a bank. All that is required is one rogue trader. Blow-ups keep happening. For banks, good trading is at best a bonus. It is not something solid and everlasting to fall back on for eternity.

Well, that’s what most or all “developed” international banks are doing. They are relying on their international trading operations to see them through these times. (((Compare this to an emerging market like India, where an HDFC Bank generates 30%+ QoQ growth, for the last 8 quarters and counting, on the basis of actual business profits from new accounts, savings and fresh real money that increases the float))).

While the scenario lasts, what kind of synthetic products can one expect from the plastic composers of financial products?

And we are going to get something plasticky soon, since “developed” international banks have gotten into the groove of trading, and since trading is their ultimate bread and butter now.

So what’s it gonna be?

The conceivers of plastic in the ’80s still had a conscience. For example, Michael Milken’s “Junk Bonds” still had actual underlying companies to the investment. That the companies were ailing, and could probably go bust, was a different issue. In lieu of that, junk bonds were giving returns that beat the cr#p out of inflation twice over, and then some. Though investors knew that these underlying companies were ailing, greed closed their eyes, as crowds lapped up the product. We know how the story ended.

In the ’90s, anything with the flavour of IT ran like an Usain Bolt. The conceivers of plastic products here were tech enterpreneurs, coupled with bankers that pushed through their IPOs. One had a lot of shady dotcoms with zero or minus balance-sheets clocking huge IPOs, apart from being driven up to dizzy heights by greedy public, from where their fall began.

By the ’00s, whatever 2 pennies of conscience that remained were now out the window. Products like CDOs did the rounds. These had no actual underlying entity, like a bond or a debenture. They were totally synthetic, mathematical products, assembled by bundling together toxic debt. The investment bankers that conceived these products knew that the debt was toxic, and were cleverly holding the other end of the line, i.e. they sold these products to their clients as AAA, and then shorted these very products, knowing that they were bound to go down in value because of their toxic contents.

We are well into the ’10s.

What’s it gonna be?

I think it’s probably going to be a “Structure”.

There is going to be an underlying. The world is wary about “no underlyings”.

The catch is going to come from the quality of the underlying, as in when it’s ailing badly and the world thinks otherwise (in the ’80s, the junk value of the underlying was no secret. Here, it probably will be).

Where is the product going to be unleashed?

Emerging markets. That’s where money has moved to. Also, investors there are not as savvy, since they’ve not been properly hit.

Why is the time ripe?

Interest rates are kinda peaking. Investors have gotten used to sitting back and raking in 10%+ returns, doing nothing. When interest rates start to move down, that would be the stage for the unleashing of the product in question.

Lazy, spoilt investors would probably lap up such products offering something like 13%+ returns, with “certified” AAA underlying entities to the investment.

So watch out. Don’t be lazy or greedy. As and when interest rates start to move down, move your money into appropriate products that are not shady and that have safe underlyings. From knowledge, not from hearsay.

Be very selective about who you let in to give investment advice. Even someone you trust could be pushed by his or her employer institution to aggressively sell you something synthetic with a shady underlying.

Be very, very careful. Do your due diligence.

Don’t get into the wrong product, specifically one with a lock-in.