tell me more abotu th eiron butterfly stradegy
1. Buy put option on S&P 500
Ex: You buy a $2,000 put option on SPY (S&P 500 ETF) for $100. That means you have the right to sell the SPY at $2,000 any time before expiration.
2. Sell a put option on S&P 100 for twice as much ($4,000)
So now you have: - 2,000 SPY puts that you bought for $100 each = $20000 - and 4,000 S&P 100 puts that you sold for $200 each = $80
3. Net = $6,000
You're making money even if there is no movement in the market. In this case, since you sold more puts than puts you bought, your net profit is going to be whatever the difference is between the two options. Here it's about 6%.
4. Buy put option on Dow Jones Industrials Index (DIA) for half as much ($1,000) and do same thing with puts on DIA
Now you have: 10,000 SPY puts worth $10,000 and 10,000 DIA puts worth $2000 = net worth of 20% again even if there is no change in market. Your profits are based on how much more expensive those Dow Jones options are compared to the SPY options. This strategy can be used with any two indexes or stocks but I like using index funds because they are cheaper than individual stocks and easier to trade.
5. Do this over and over until expiration date (about 3 months away)
At expiration day all your positions will automatically get closed out at whatever price they settle at. If SPY goes up then all your put positions will automatically lose money because they will be worth less than when you bought them. Whatever losses from those positions will offset gains from other positions so your overall profit or loss will be determined by how the market moves during that time period. The beauty of this strategy is that it doesn't matter what happens in the market during those three months because your profits or losses will cancel out regardless of what happens in that period of time. You could have an absolutely terrible month but still make money overall if the market moves enough one way or another during those three months so your gains/losses offset each other .
6. Why does this work? It's arbitrage!
The way markets work is that every stock/index has a "premium" attached to it based on supply/demand factors related to how many people want to buy vs sell these things (i.e., demand for hedging). When someone wants to buy an option they want it at a lower price than when they want to sell an option because they want to lock in their profits (or prevent losses). So when someone wants to sell an iron butterfly they want a higher premium than when someone wants to buy it because they don't want their position getting unwound by some hedge fund buying back their options at lower prices later on. So if there's too big of a discrepancy between buying and selling prices then someone can make money by buying low and selling high until those prices converge back together again after several weeks or months depending on expirations dates.. The bigger these premiums are between buying and selling then the more money can be made doing this strategy (assuming volatility stays about the same). And typically there's not too much volatility around earnings season so this is usually a good time of year for doing this strategy.. Note that I am not recommending anyone do this! I am just explaining how it works since people always ask me about it after I describe it here..