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Rising Star Teaches Me About Options Greeks and Free Butterflies | Rolling Trades Series

May 21, 2021

By: Vonetta Logan

OK so this is definitely the most posh episode of Rolling Trades. I felt like Oprah interviewing the exiled members of the Royal Family. I picture me and Harvinder sitting on a luxurious patio in Malibu, me, removing my glasses, leaning forward and saying, “who is having THAT conversation...about delta to theta ratio.” Then Harvinder mentions that he sometimes trades with the Queen. Then a pack of corgis runs by. It would be gonzo ratings! 

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But alas, we still had to do this whole episode via Zoom. Harvinder is one of our most beloved Rising Stars because, duh, that accent! Also, he knows what he’s doing when it comes to trading and you gotta love the dedication of someone managing to trade the US markets even though they’re 6 hours ahead time wise. 

So there are 2 huge takeaways (also what the British call takeout) from this episode: 

Using the Greeks for Successful Options Trading

Harvinder says you should, “use your Greeks like a shopping list.” Use your Greeks before you enter a new position to know what to change about your portfolio. Consult your Greeks to get your portfolio metrics to where they need to be. Uh, that’s great, Vonetta where does my portfolio need to be? Bloody great question, mate! (Damn, is that Australian...have I slipped into Australian?) Here are Harvninder’s metrics from the episode. 

  • theta/ net liq ratio- 0.1- 0.3 if implied volatility has expanded

    • We want to have positive theta overall to ensure that extrinsic value is decaying in our favor over time, which helps us offset directional moves against us.

    • The higher implied volatility is, the more aggressive we will be with our theta targets naturally, as high implied volatility indicates a large amount of extrinsic value compared to a low implied volatility environment 

  • Delta to theta ratio 2:1 ratio and that’s short delta 

    • If we lean directional, we want to ensure we have some positive theta to offset moves against us

    • Short delta helps offset implied volatility expansion against us when markets sell off, so it is a natural hedge against short premium trades

Most importantly, we learned the difference between static and dynamic delta. 

Static delta doesn’t change in value even if the underlying price moves. Stock has static delta and allows traders to keep hedges consistent regardless of where the stock price moves.

Short 100 shares of stock, your delta exposure doesn’t change as the stock price moves up and down.

Dynamic delta applies to options trades, since the delta of each option changes as the stock price changes. This is because strikes are static once the trade is entered, and the stock price moves around them. 

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At expiration, strikes that are in-the-money (ITM) will have a delta of -100 or 100. Strikes that are out-of-the-money (OTM) will have a delta of zero.

Options, baby! Options Delta is influenced by changes in price and also changes over time. Influenced by DTE and changing stock prices, whereas static delta never changes. 

How to Create Free Butterflies 

We also learned that high probability strategies are great for times of low volatility. You’re hoping that the Probability of Profit (POP) will help you out of a jam if things go south. It’s like how dogs rely on being cute when they destroy your shoes. 

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Ratio spreads and Broken Wing Butterflies (BWB) are high probability of profit (POP) trades. Harvinder likes to turn these high POP trades into something he learned on Market Mindset - free butterflies. Here are the steps to creating a free butterfly trade: 

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  1. Look to see if there is call or put skew. If there’s call skew, then you will collect more premium if you do a call ratio spread and you can also go wider. And that’s great, but you should also factor in your own assumptions about the stock and the market in general. For the Chewy ratio spread we finance our put spread by selling a naked put. That naked put is where all of our risk is. Are you comfortable with that risk at say the 30 delta? If not, a broken wing butterfly may be your choice instead.

  2. Open your initial position, either a ratio spread or a broken wing butterfly. Even though ratio spreads are undefined risk, they have high POP, so in Harvinder’s style of trading the risk is worth the reward. He likes to go 45 days out for both strategies. Both strategies involve buying a long spread, and financing the entire cost of the debit spread with an extra short option (ratio spread) or wider short spread (BWB).

  3. We want the stock to move away from our strikes so we can keep the premium we collected for the trade. 

    • To get to the “free fly” we need to create a butterfly that has an equidistant long spread and short spread, but do so for less than the credit we collected up front. This is what locks in a profit, and removes the initial risk from the trade.

    • For ratio spreads, this means buying an OTM option to create an equidistant butterfly. For BWBs, this means rolling the existing long option that is part of the credit spread closer to the short option, creating an equidistant butterfly

    •  Say 5 days later in Harvinder’s example, if the stock goes up a bit with a put ratio spread, we can buy the 70 put for less than the premium we received up front and create a “free butterfly”. So if we put the trade on for a 2.43 credit and in 5-10 days the 70 put is trading for less than that amount and we buy it to create an equidistant butterfly, we have no risk in the trade and we’re guaranteed a profit! 

  4. After we create the free butterfly, we actually want the stock price to reverse towards our spread, so that our free long spread can appreciate in value. In this case, our long put spread would achieve max profit and the short put spread would still lose value as long as it is not ITM at expiration if the stock drops towards our short strikes. 

  5. If the stock gets to or even breaches your breakeven, you still have a long debit put spread that would have reached max profit because of the bearish nature of that strategy. So close your long debit spread for max profit, then roll your naked short 75 put into the next cycle, and sell out of the 70 strike put as well if you’re comfortable with a naked short put. This results in a big credit with just a short 75 put remaining in this example.

    •  You can also straddle it off, and add the naked short 75 call or you can get assigned the stock and then sell a call against it, creating a covered call, which gets you more premium and maybe even dividends now from the stock that you own. 


Keep Learning from Options Trading Experts

Did you guys get all of that? All properly sorted, and Bob’s your Uncle. It’s all about maximizing all of your trade opportunities and using probabilities to your benefit. I love anything with free in the title. Harvinder believes in building a trading community. Whether that is watching the show, joining a Facebook group, or even hopping onto a reddit chat board. No one trades in a vacuum, and it's great to tap into a community of like minded people. So keep calm and trade on! See you next week! 

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Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

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