move down, the strategy could potentially
Keep in mind the overlapped positions
maintained your original speculation. The
strategy is long vega because the long two
strangles in the back month can have a
higher vega than the long butterfly in the
near month. And the strategy may be profitable if the stock has a very large price move.
Figure 1 shows how two long strangles
and one overlapping long call butterfly
Consider a case when the market has had
a big rally and you’re bearish. Again, you’re
not trying to time the market. So you may
buy a put vertical in a further expiration.
But what if the market rallies a bit, or even
just sits there for a while? Neither could be
good for that long put vertical. So, you might
overlay a short put vertical in a closer expiration that would have narrower strikes.
You may want to ratio these overlapped
verticals with two debit spreads to one
credit spread, for example. This gives you
more negative deltas in the back month,
and fewer positive deltas in the front
Thomas Preston is not a representative of
TD Ameritrade, Inc. The material, views, and
opinions expressed in this article are solely those
of the author and may not be reflective of those
held by TD Ameritrade, Inc.
For more on the risks of trading and trading
options, see page 37, #1– 2.
FIGURE 1: Strangles overlapped with a butterfly. From the Trade page on thinkorswim, select the
expiration and strike price to place strangles and a butterfly. Source: thinkorswim® from TD Ameritrade. For illustrative
FIGURE 2: Two long put verticals overlapped with a short put vertical. Right-click on the strike prices
to buy and sell two put verticals. Source: thinkorswim® from TD Ameritrade. For illustrative purposes only.
month, to keep the overall strategy bearish.
But the bullish, short, front-month vertical
can chip away at the breakeven point of the
back-month bearish long verticals.
For example, with the stock at $50, maybe you buy two of the long put verticals,
long the 51 strike put and short the 48 strike
put in an expiration 60 days out for $1.20
debit. On top of that, you sell one put vertical that might be short the 50 strike put and
long the 49 strike put, with an expiration 30
days out, for $0.45 credit.
If the stock rallies from $50 to $52 in 30
days, that’s not good for the long 51/48 put
verticals, which might be $0.80 now, and
may have lost $80 ($0.40 x 2). But the short
50/49 put vertical would have its max profit of $45, and reduce the overall position’s
loss to $35.
On the other hand, if the stock is down
to $48 in 30 days, the long 51/48 put verticals might be worth $2.20, and be up $200
($1 x 2), while the 50/49 put vertical has its
max loss of $55 ($1 – $0.45 credit). Overall,
the strategy is up $145, not including commissions.
Figure 2 shows how two long put verticals and one overlapping short put vertical
might look. The short put vertical overlay
has its downside. But its purpose is to offset
the loss on the long put verticals if the stock
continues to climb.
Overlaying verticals gives you a lot of
flexibility. If the stock continues to rally,
you could attempt to roll the long put ver-
tical to higher strikes—potentially taking a
loss—but also sell a higher-strike put verti-
cal in a closer expiration (possibly a weekly
expiration) to offset the loss.
OVERLAPPING S TRATEGIES IS NO MAGIC
formula to guaranteed profits. The goal is to
potentially reduce the risk of a longer-term
or core position. And each part of the overlapped strategy plays a specific role that you
should understand. Again, keep in mind that
a potentially helpful strategy in one scenario
can hurt in another. But why the overall
strategy might make or lose money can be
easier to figure out if each position has a
clear purpose in relation to the other, and
can be analyzed as its own, separate trade.
The point isn’t to get super complex in
your trading life to wow your friends, but
to fine-tune a speculation that could potentially be more profitable with less risk.
WHEN MARKETS ARE HIGH,
BUT YOU DON’T KNOW WHEN
THEY MIGHT FALL BACK
POSSIBLE STRATEGY: A LONG BACK-
MONTH VERTICAL WITH SHORT
FRONT-MONTH VERTICAL OVERLAY
Typically a market-neutral, defined-risk strategy, composed of
selling two options at one strike and
buying one each of both a higher-and lower-strike option of the same
type (either all calls or puts). The
strategy assumes the underlying
will remain relatively unchanged
during the life of the trade, in which
case, as time passes, and/or volatility
drops, the combined short option
premiums exhibit more decay than
the combined long option premiums,
resulting in a profit when the spread
can be sold for more than its original
debit (which is its maximum loss).
A trading position involving puts
and calls on a one-to-one basis in
which the puts and calls have the
same expiration and underlying
asset, but different strike prices.
When both options are owned, it’s a
long strangle. When both options are
written, it’s a short strangle.