Overview:

I’m sorry to say that I’m always bearish.  I take that back . . . I’m not sorry.

Unfortunately for myself and any other Russell bears out there, $RUT snapped higher this week and that’s putting the Butterfly position under a little pressure.  The next adjustment point for the Butterfly is a $RUT price around 1220 and the overnight action in the Futures suggests that we’re likely to open at or above that level.  As a result, it’s time to take a look at a few upside adjustments for the Butterfly.

The daily chart below shows the recent price action in the Russell 2000.  Russell was able to to close up and above the high from a few days ago and has all of the daily moving averages in bullish order, which suggests we could start moving higher.  The recent all time high around 1221 looks like a nice target for the Russell.

Existing $RUT Position:

The risk graph below shows the current $RUT Butterfly position with 34 days to expiration.  The position is made up of two 50 point wide Put Butterflies, centered at 1160 and 1180, and two $IWM calls to hedge the short delta.  Yesterday $RUT closed at 1216, which is about 4 points away from the 1220 adjustment level and slightly outside of the expiration tent.

Our goal with any adjustment is to bring $RUT back under the tent while keeping the T+zero line relatively flat and preserving the greeks.  Specifically, we want to stay slightly short delta, short a small amount of gamma, positive theta, and negative vega.

$RUT Butterfly Adjustments:

We’re going to consider 4 different adjustments for the Butterfly including adding another 50 point butterfly at 1200, rolling the 1160 (lower) butterfly to 1200, adding a 40 point by 30 point broken wing butterfly at 1210, and adding a 50 point by 40 point broken wing butterfly at 1200.  Regardless of the adjustment we make, our next adjustment point will move up to around 1230.

$RUT Butterfly Adjustment #1:

The first butterfly adjustment is to add another 5 point wide put butterfly centered around 1200 (1150/1200/1250).  An image of the position after adjustment is shown below.  This is the most aggressive adjustment of the four from a capital standpoint and has the negative effect of increasing risk in the trade.

$RUT Butterfly Adjustment #2:

The second adjustment adds the same Butterfly discussed in Adjustment #1, but it also sells out the lowest 50 point Butterfly.  In other words, this adjustment rolls the 1160 Butterfly to 1200.  The risk graph below shows the position after the adjustment.

$RUT Butterfly Adjustment #3:

The next adjustment is the least aggressive of the 4 from a capital standpoint.  This adjustment adds the 1170/1210/1240 Broken Wing Put Butterfly.  The Butterfly is 40 points wide on the downside and 30 points wide on the upside.

$RUT Butterfly Adjustment #4:

The fourth adjustment is similar to the third and is a slightly more aggressive broken wing butterfly.  This adjustment adds the 1150/1200/1240 Broken Wing Put Butterfly.  The Butterfly is 50 points wide on the downside and 40 points wide on the upside.

Whoa, that’s way too many options!

The challenge with the Butterfly Adjustment choices above is that there are almost too many options to consider.  For me, things start to get a little murky when I get beyond two or three options.  Additionally, there are other options we could consider like rolling up short puts, adding long calls, or adding call debit spreads.  The following table makes it easier to understand the implications of the adjustments.  The table below goes through the position greeks and break even points for the T+zero, and T+7 lines in the trade.  Since 1230 is our next upside adjustment point, the table also compares the open loss at that level.

Looking at the table above, some of the things we already know about the adjustments become more obvious.  Specifically, adding another 50 point Butterfly significantly increases the risk at the 1230 adjustment point and rolling up the 1160 gives the position quite a bit of room to breathe.  My preferred adjustments are #2 and #3.  The benefit of the #3 adjustment is that it does less to flatten the T+zero line and the position will come into the money more quickly on a pullback.  That being said, a week from now the difference is negligible.

The trade is now under 35 days to expiration and theta will start lifting the T+zero line quickly.  We just need to stay in the position long enough for that to happen without taking on too much additional risk.  I’m planning to adjust using either adjustment #2 or #3 above if we hit 1220 this morning (likely).  Make sure to check back here tomorrow for the Market Commentary to find out what happens.

Update as of 8am MST:  I rolled the 1160 Butterfly up to 1200, which is option #2 above.

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