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When Should I Use a Butterfly Spread?

June 3, 2021 by Daniels Trading| Tips & Strategies

In trading, as in life, timing is everything. Often, the difference between winning and losing is not what you do but when you do it.

For traders who want to implement butterfly spread strategies, the timing quandary is no different. Read on to learn more about these types of trades and when executing one is a good idea.

Timing the Butterfly Spread

A butterfly spread is an advanced trading strategy that involves simultaneously buying and selling multiple futures or options contracts. The primary goal of this strategy is to optimize risk and reward while capitalizing on a market bias. However, although the concept is the same in both the futures and options versions, there are nuances that you need to understand.

Futures Market Applications

In the futures markets, the butterfly spread consists of buying and selling like contracts with unique expiration dates. By implementing this strategy, a trader is positioned to profit from rising or falling asset prices while being insulated from unexpected periodic volatility.

We’ve been assisting our clients in making sound trading decisions for over 25  years.  Trust a Daniels Trading broker to help you reach your trading objectives in  any market.

To illustrate how this strategy works in futures markets, let’s take a look at a real-world example. In the following scenario, assume that Corey is a Nebraska corn farmer who is expecting a bumper crop in the coming year. This should bring an abundance of supply come harvest time and place pressure on CME corn futures (ZC) pricing. After planting is complete (early June), Corey executes the following trade:

  • Buys one lot of July ZC at 647’0
  • Sells two lots of September ZC at 576’0
  • Buys one lot of December ZC at 543’0

Structurally, Corey’s spread has two legs: July/September and September/December. By executing the strategy shortly after planting, Corey is insulated from bullish July volatility while still holding a bearish view toward harvest pricing.

So why place this trade? In short, to address potential market uncertainty. In commodities such as corn, supply and demand levels vary throughout the year, as do prices. For Corey, a midsummer spike in corn prices would hurt a naked fall short hedge; by taking the aforementioned actions, he can mostly mitigate this risk.

Options Market Applications

An options butterfly spread is a “neutral market” strategy that involves the buying and selling of four call and put contracts with identical expiration dates. The trade is executed by purchasing or writing at-the-money (ATM) and out-of-the-money (OTM) contracts at three different strike prices. This type of spread is used to secure bullish or bearish market exposure with a finite profit/loss matrix.

To say the least, the mechanics of multi-legged options spreads are complex. To learn more about how this one functions, check out our dedicated blog post on the topic, “What Is a Butterfly Spread Option Strategy?”

So when should one put on an option butterfly spread? Here are few instances in which you may want to consider executing the strategy:

Moderate Bullish/Bearish Bias

In the event that implied volatility is expected to be modest, this type of spread can be exceedingly profitable. If price doesn’t move much from a base level, both the bought and sold contracts may expire in the money (ITM). However, when dealing with trending markets, buying calls or puts outright offers a potentially greater upside.

Capital Constraints

The vast majority of retail traders operate with limited capital. In this case, butterfly spreads can be used to secure market exposure while limiting liabilities. Because of the simultaneous buying and selling of contracts, the money needed to initiate the trade is vastly reduced, as is the assumed risk.

Is Spread Trading Right for You?

Without a doubt, futures and options spreads are among the most confusing subjects in all of finance. However, despite their intricacies, they can be useful in achieving almost any financial goal.

If you’re new to the world of spread trading, don’t be intimidated―enlist the services of a Daniels Trading market pro instead! Sign up for your free one-on-one futures and options consultation today.

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Filed Under: Tips & Strategies

About Daniels Trading

Daniels Trading is division of StoneX Financial Inc. located in the heart of Chicago’s financial district. Established by renowned commodity trader Andy Daniels in 1995, Daniels Trading was built on a culture of trust committed to a mission of Independence, Objectivity and Reliability.

Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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