Butterfly Course Part 11 – The Bearish Butterfly


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Read Part 1 – The Basics
Read Part 2 – How To Set Profit Targets and Stop Losses
Read Part 3 – How To Successfully Leg Into A Butterfly
Read Part 4 – Trading Rules
Read Part 5 – Using Low Risk Directional Butterflies
Read Part 6 – The Greeks
Read Part 7 – Broken Wing Butterflies – One-Size Fits All
Read Part 8 – The Reverse Butterfly
Read Part 9 – Using Butterflies In A Combination Or As A Hedge
Read Part 10 – How To Protect Against Fast Moves

The Bearish Butterfly is an advanced rules based strategy developed by a friend of mine called John Locke (no, not the guy off Lost). I won’t go into too much detail here, but the basic premise is that you enter a butterfly below the current stock price and then use reference points to add to, or adjust the trade. You start with one-third of your total position size and then add the rest if the market rallies.

Keep in mind the bearish butterfly trade outlined here is a high risk, high reward trade so it’s not for everyone.

The trade is always entered with 56 days until expiry. RUT is the favored instrument and the initial butterfly is centered 20 points below the current RUT price. Your reference point is the centre of the butterfly and the adjustment points are then calculated as follows:

Reference point +40 – add second 1/3
Reference point +60 – add last 1/3
Reference point + 70 – roll lowest butterfly +60
Reference point + 80 – roll lowest butterfly +60
Reference point + 90 – roll lowest butterfly +60

So assuming at initiation of the trade RUT is at 1050, you enter a butterfly with 1/3 of your position size, centred at 1030. If RUT then rises to 1070 (i.e. 40 points above your butterfly centre), you add the second butterfly centred at 1050. If RUT then breaks 1090, add the last butterfly at 1070.

If RUT continues to rally and breaks above 1100, close the 1030 butterfly and move it to 1090.

In terms of risk management rules and profit target the guidelines are set out as such:

Start with 20 contracts (10 butterflies) for the short strikes and scale to 60 contracts if fully scaled into. Of course you can reduce these numbers if you have a smaller account size.

Wing Span – Anything from 20 to 50 is ok. The wider the spread, the more expensive the trade, but the larger the profit zone

Planned Capital – $50,000

Minimum Capital Suggested in Account – $100,000

Profit Target – $15,000

Reduced Profit Target – $5,000… 21 DTE or closer

Max Loss – $15,000

Some people like the rules based approach of the bearish butterfly, but it’s not for everyone.  The strategy relies on the fact that at some point the market will provide a pullback into the developing profit zone that you are creating with the bearish butterfly. Markets that grind higher without much of a pullback such as we have seen a few times in 2013 can be a disaster for this trade.  When this trade loses, it can lose big.

  1. Tom Carlson says:

    Enjoy your site. Where would the bearish butterfly be adjusted in the event of downward move? Are positions ever added on the way down?


    Tom C

    1. Gavin says:

      Hi Tom, yes you can add to it on the way down as well. I’ve done that successfully a couple of times.

  2. Eric P says:

    It looks like starting 20 pts down from current price brings you to a DELTA. Of around 35%

    1. Gavin says:

      Yep generally speaking that’s about right.

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