# 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’s on your mind, Mr. Nath?

Any questions, Mr. Nath?

Ya, I did have something on my mind.

I want to ask someone else.

Who?

Mrs. Market.

How are you going to do that?

I’ll just imagine that I could.

And, what’s the question, for the sake of discussion?

It’s not so much a question, really…

What is it then?

An observation perhaps…

…or a regret, maybe…

… not able to pinpoint exactly.

Hmmm, why don’t you just say it in words.

Rewiring?

Yes. The words coming out are “Couldn’t you rewire us earlier?”

Who’s the you?

Mrs. Market.

Doesn’t your rewiring depend upon you?

Yes, that’s why perhaps it’s more of a regret.

What is this rewiring?

We are taught to win in life, and to hide our losses, if any, under the rug. That’s how we grow up. And that doesn’t work in the markets.

True. That’s what needs to be rewired?

Yes, to win in the markets, we need to get accustomed to loss, small loss, as a way of life. Wins are few, but they are big. So big, that they nullify all losses and then some. We make these wins big by not nipping them in the bud.

How long did it take you to rewire?

Seven years.

What’s your regret? A shorter time-frame would have resulted in half-baked learning.

You are right, it’s not a regret then. Let’s just call it an observation.

It’s a very useful observation for someone starting out in the markets.

Let’s pin-down the bottomline here.

And that would be?

Till one is rewired, one needs to tread lightly. No scaling up…

…till one is rewired.

And how would one know that one’s rewired?

No sleepless nights despite many small losses in a row, because one has faith in one’s system. Resisting successfully the urge to take a small winner home…

…because it is this small winner that has the potential to grow into a multibagger…

…and a few multibaggers is all that one needs in one’s market-life.

# The One Big Thing That Sticks

We try many things…

…in the markets.

For many years do we labour.

Strategies come, and they go.

Some stick.

After running through many, many plays, we find a handful sticking.

We take them.

Some still wither away.

Others get bigger.

Eventually, one is the biggest.

Why?

You enjoy it.

You’re good at it.

It comes naturally.

Others aren’t fun.

You’re tense with others.

This one, oh, this one’s another ball game.

It just flows.

And so do you.

You start to scale it up, unknowingly, at first.

Eventually, realization sinks in.

This one thing that’s sticking so well…

…yeah, this is your life’s work.

You’ve already scaled it up to a point of no return…

…and that’s ok…

…because you don’t want to turn back.

You’re now going to toil to make your life’s big work reach its logical conclusion.

That’s the least that it deserves, and you’re just going to enjoy the ride…

…apart from using its proceeds to see your lot and others soundly through life, and then some.

# Getting the Number

There comes a time in life…

…when you are in a position to make defining statements about yourself.

This is what you don’t like doing.

Shove it out. Except what you can’t.

This is what you like doing.

Amongst what you like doing, this is what is beneficial for you.

Make a list for this last category.

A.

B.

C.

D.

E…

…etc.

Get the number…

…in these categories.

What does that mean?

It means, scale these activities up.

There will be resistance.

Don’t bother.

This is what you’ve come to do.

First up, you’re going to do it.

Many times, you’ll find yourself slipping into the other category, of things that you like doing, but which are not necessarily beneficial for you.

Fine.

That’s also what you’ve come to do.

Intermittently, you’ll be doing stuff that you don’t like doing, but aren’t able to shove out.

This stuff is also good for you,…

…because, it teaches.

Just do it with that attitude.

Once you’ve gotten your numbers in your earmarked category, you can shift gears a bit.

Voila, you start doing stuff that benefits others.

You’ve achieved.

It doesn’t give you a kick anymore.

Now, benefitting others will give you a kick.

Go for it.

Of course.

It’s something you came to do too.

Make sure you get here.

Don’t get stuck somewhere before you reach it.

# Nath on Trading – II – Building up on Basics

21). You started small, right?

22). Ultimately, you’re staying consistently in the green, correct?

23). Then it’s time to scale up. Slowly does it.

24). Why the whole spiel about starting small? You make your biggest mistakes in the first seven years.

25). Hopefully, you don’t repeat a mistake once it has happened, and once you’ve learnt from it.

26). However, mistakes are good, because they teach you. Nothing else can teach you with incorporation into DNA. Mistakes can.

27). No university can teach you. No books. No professor. Play the market, make the mistake, and learn.

28). A big break early in the markets is a recipe for disaster. More likely than not, you’ll blow up later, when it matters.

29). The best possible way to scale up is using position-sizing as delineated by Dr. Van Tharp.

30). The good thing about position-sizing is that it makes you scale down, when trading corpus goes below par.

31). Day trading takes up the day. You’re exhausted and are not able to do much else.

32). Short-term trading also keeps you riveted to the terminal, mostly.

33). However, position trading and longer time frames keep you in the line for whatever else you wish to achieve.

34). Market TV makes it a video game. Switch it off.

35). Trading with targets caps big-win potential.

38). …selling low and buying back lower…

39). …as opposed to successful investing, which is buying low, not selling for the longest time, and then selling for a multiple.

40). Read points 16 to 19 again.

# We’ll Take Boring

Boring…

…is good.

Boring means…

…that you’re on the right track.

We’ll take boring.

Equity.

When it’s working according to plan, yeah, you got it, it tends to become a bit boring in the long run.

Don’t get alarmed.

That’s exactly where you want your equity to be.

When it’s there, it’s fulfilling its function, and then some.

You’ve moved away from euphoria.

You’ve moved away from fear.

You’ve arrived at boring.

Look no further.

# Useless vs Useful Expansion

I’m guilty of useless expansion.

I end up doing it all the time.

Can’t help myself, you see.

I like to keep exploring new stuff in the market.

The silver lining is, the even though I might be expanding sideways, there are two good things happening also.

There is no scaling up happening immediately. Good.

There is also a lot of discarding going on. Things that don’t work out are eventually abandoned. Great.

My issue is that I might have between 1 to 2 useless strategies in my repertoire at any given time.

These strategies are not working. In fact they are dying out. Reasons can be many. A strategy might be sound, but it might not be a fit.

For a strategy to work for you, it must be practically lucrative in the long run, and it must fit you.

By the time I realize that a strategy needs to be discarded, money has been lost. Tuition fees? Yes.

Ultimately, things boil down to a handful of successful strategies. It can even ultimately boil down to one or two successful ones.

Get there. I’m trying too. To do so, useless strategies will need to be discarded, like, now.

The problem is, you don’t know that a strategy is useless till it has hit you a few times.

Also, you don’t wish to discard something that you think might just work out for you in the long run.

Fine. Keep grinding, and ultimately narrow down your sideways expansion, till you’re only working with strategies that are yielding, and show a long-term promise of being around.

Right.

You’re there.

Now you can scale up. Doing so using a yielding strategy that fits is called useful expansion.

Scale up slowly.

You can position-size, and scale up using profits. This way you are not putting in extra principal. Let the strategy continue to prove itself by yielding. As long as it does so, you keep scaling up on your positions using the newly earned profits.

Why is useful expansion not easy to maintain?

We get carried away.

We might scale up too fast, and then baulk at a loss when the size of the loss is too difficult to swallow. Large input can result in a largish potential loss.

Scaling up too fast makes an early loss look big if we haven’t tasted the corresponding potential profits yet. Such an event can even cause us to abandon a successful strategy because we are disheartened.

Therefore, try not to scale up by putting in new principal, if you can help it.

Try scaling up on profits alone.

Position-sizing automatically controls the scale-up-scale-down factors by defining the size of a constant stop as a percentage of the principal remaining between trades.

Position-sizing makes one scale-up and scale-down on auto-pilot in a relatively balanced fashion.

Please incorporate this wonderful ideology (which comes from the stable of Dr. Van Tharp) into your trading strategy.

🙂

# Going for the Jugular

It’s time.

Why…is it time?

And, time for what?

It’s time to go for the jugular.

Meaning?

There comes a time, when, after working hard, struggling, doing the whole jig, the rigmarole, you achieve your basics.

Well done. Pat on your back.

Then you secure these basics.

Forever.

If you can.

Wonderful. More pats.

Worry factor is now out of the equation.

Food, safety, education, all basics intact.

Fantastic. You deserve an award. Not that anyone’s going to give you one. Frankly, nobody could care less. Never mind. You know in your mind that you’ve achieved a milestone, and that’s enough for you.

Whats the next step…

…for you?

Jugular.

What is this jugular?

Multiplier.

X-factor.

Call it what you will.

What does this mysterious thing do?

Better question is, what is it capable of?

You’re looking to multiply your networth.

Isn’t everyone?

This is different.

Why?

Because it is coming as a logical conclusion, and not as a first-step with no experience and no secure basics.

Nothing is touching these. You’ll be surprised at the kind of courage secure basics give you to act further.

Next, you’ve identified an area where your skill-set can be leveraged into huge profits with minimal risk.

Specifically in the market, these areas are abundant.

So what exactly will you be doing?

Playing on a minuscule portion of your net worth. Let’s say not more than 2 %.

Leverage.

Stoploss.

Profit-run.

Position-sizing. Scaling up upon profits. Scaling down upon losses.

Fear.

Worry.

Hypertension.

Exuberance.

Hubris.

Complaecency.

Going beyond.

Multiplying.

Going for the jugular.

# Scaling Up

When you find a system…

… that works…

… what’s the next step?

Plunge?

Wait.

Look left and right.

Meaning?

Are they in place?

Meaning?

No worries about food on the table?

No worries about kids’ education funds?

Basic family luxuries in place?

No?

Get these together and going.

Yes.

Ok.

Go for it.

Scale up.

Your decision to scale up should at no time endanger your basics.

You’re scaling up from  your extras.

You’re scaling up with stops in place.

If your stops are hit, you’ll change your system till it works again.

You will not borrow from your basics.

You will wait for your extras to accumulate, and divert these into scaling up.

Having gotten all that out of the way, let’s cast a glance at the concrete process.

1x is working, or so you say.

In fact, you’re sure 1x is working.

Ok.

Now do 2x.

Working?

5x.

Can you take it?

Do you sleep well at night?

Fine.

10x.

Working?

Family life intact?

Basics intact?

Fine. You take it from here.

Where do you plateau?

Right before a level where something might get disturbed.

It’s really that simple.

Happy scaling up!

🙂

# Monotony

Plan in motion?

Let it play.

Sure, monotonous.

Monotony bores you, right?

Boring monotony yielding acceptable results is a good outcome. Don’t spoil its party.

Try a stunt.

Risk a little.

Maybe one out of your ten stunts works out.

Develop this one further.

Still working.

Scale it up slowly.

Working.

Auto-pilot.

Monotony.

Results still good.

Stop looking.

Let it play.

Look elsewhere.

Do something new with yourself.

Soon, it’ll be time to go.

Meanwhile, build a legacy to leave behind, in your memory, one that benefits many.

# Making it Count

You’re playing a big one.

What’s foremost?

Make it count. For heaven’s sake.

Why?

Big plays don’t come too often. When they do, you have to catch them. You need to have energy left, to play. Then you just go all the way. Till the play plays itself out.

Life is an accumulation of knicks and knacks.

At first, you don’t know what you’re good for.

When you do know it, you start out as a net-net loser in whatever you’re good for, because every rookie needs to pay tuition fees. These are the costs of your mistakes.

Then you start getting the hang of something you’re naturally good at. Tricks of the trade – you learn them. You succeed in making your activity applicable, perhaps even financially viable.

Next step is to scale up.

You need to make your successful model count. Period.

Tired? Want to do other things? Need to borrow? Too big a pain? Time-issues? Overdose? Bureaucracy?

Whatever.

Don’t lessen the flow. Hold on. Ask the Universe for reserves. See the play through.

One life can mean just a few big plays.

When you’ve latched onto one, and have set it up so beautifully, now’s the time make it count.

Best of luck!

🙂