What Multi-Leg Options Strategies Can Help in a Flat Market
Traders need to be flexible in all types of market environments, whether bullish, bearish or flat. Options, especially multi-leg options, can provide traders with ways to customize their strategies to suit their views on the market’s direction.
Multi-leg options, also called complex options, simultaneously buy or sell options of the same underlying security. They offer traders three main benefits:
● Time saving: Multi-leg options can save time in a fast-moving market. Instead of executing each leg of the options trade one at a time, traders can carry out a strategy with a single order and remove the time lag between each option entered manually. A slower trade using single-option orders can increase slippage as prices change between executions.
● Cost effective: Multi-leg options tend to be slightly less expensive than single-option orders because the proceeds the trader makes from selling options can offset some purchase costs. The flip side of this is that there will be slightly higher commission costs with multi-leg strategies, and profit ranges may be more limited than single-leg options.
● Versatility: Multi-leg options allow traders more versatility in their trading by offering more tools in the toolbox to take advantage of bull, bear, and neutral markets. Traders can tweak strategies to limit or increase risk as well as maximum and minimum profits, allowing a wider range of trades that can be tailored to more scenarios.
Keep in mind that multi-leg options involve risk and are not suitable for all traders. Transaction costs may be significant in multi-leg options strategies, and advanced options strategies often involve greater and more complex risk than single-leg options. Losses with multi-leg options can be greater than the initial investment. Evaluate the benefits and drawbacks carefully.
In a flat market, these two multi-leg options strategies can be useful to traders and developers who want to take advantage of the conditions:
Iron Butterfly
How it works: To create an iron butterfly, the trader buys one call option with a strike price above the target price, sells both a call and a put option using the strike price nearest the target price, and buys one put option with a strike price well below the target price.. Each option has the same expiration date. The strategy is not named after the band that sang “In-A-Gadda-Da-Vida.” It comes from the butterfly-like shape of the graph that illustrates the strategy’s profit and loss, with each leg of the trade looking like a wing, as you can see above.
Pros: With an iron butterfly, you receive a net credit into your account immediately, and you minimize downside risk with this defined risk trade. The strategy earns the maximum profit when the underlying asset closes precisely at the middle of the strike prices at expiration.
Cons: The iron butterfly limits risk, but also profitability. You need to close precisely at the middle of the strike prices to maximize profit.
Real-life example: Let’s build an iron butterfly with an example of using Netflix stock, which traded at $173 per share in early May.
1. If you think Netflix stock will stay close to $175 per share, you could buy a call option with a $177.50 strike price, sell a call option at a $175 strike price, sell a put option with a $175 strike price, and buy a put option with a $172.50 strike price.
2. This strategy would give you a $185 credit in your Lime Trader account.
3. The results:
•Profit: If, at expiration, Netflix stock closes precisely on the strike price of $175, you can earn $185, minus $2 commissions for the two wings of the iron butterfly.
•Breakeven: If Netflix stock stays between $173.15 and $176.85, you at least break even.
•Loss: If Netflix stock drops to $173.15 or below, or rises to $176.85 or above, you would lose a maximum of $65.
4. If the iron butterfly expires with Netflix stock between $173.15 and $174.99, you could end up with 100 shares, or if it expires with Netflix shares between $175.01 and $176.85, you could end up with short 100 shares, so you should manage these positions if you wish to avoid the exercise of the option.
Iron Condor
How it works: Much like the iron butterfly, to create an iron condor, the trader buys one out of the money put and sells one put closer to the money put while buying one out of the money call and selling one call closer to the money. Each option has the same expiration date. The name comes from the bird-like shape of the graph that illustrates the strategy’s profit and loss, with each leg of the trade looking like a wing, as you can see above. You can think of this as a combination of credit call, and credit put spreads that surround a center range.
Pros: With an iron condor, you receive a net credit into your account immediately, and you minimize downside risk with this defined risk trade. The strategy earns the maximum profit when the underlying asset closes between the middle strike prices at expiration. It can be modified to have a bullish or bearish bias.
Cons: The iron condor limits risk, but also profitability. While the strategy is directionally neutral, the premiums can benefit from higher volatility. However, the higher premiums result from that greater risk in a highly volatile market.
Real-life example: Let’s build an iron condor with the same example of using Netflix stock.
1. If you think Netflix stock will stay in a range between $170.80 and $177.50, you could buy a call option with a $177.50 strike price, sell a call option at a $175 strike price, sell a put option with a $172.50 strike price, and buy a put option with a $170 strike price.
2. This strategy would give you a $170 credit in your Lime Trader account.
3. The results:
• Profit: If, at expiration, Netflix stock is between $172.50 and $175, you can keep that $170, minus $2 commissions for the two wings of the iron condor.
• Breakeven: If Netflix stock stays between $170.80 and $176.70, you at least break even.
• Loss: If Netflix stock drops to $170.80 or below, or rises to $176.70 or above, you would lose a maximum of $80.
4. If the iron condor expires with Netflix stock between $170 and $172.50, you could end up with 100 shares at $172.50, or if it expires with Netflix shares between $175 and $177.50, you could end up with short 100 shares at $175, so you should manage these positions if you wish to avoid the exercise of the option.
Use a Broker Built for Multi-leg Option Strategies
Deploying multi-leg options strategies is easier when traders have a broker designed to handle them smoothly. The ease of executing multi-leg options strategies depends on the broker’s configuration. Traders should be aware of commissions owed and the broker’s margin requirements. Executing as one order allows a trader to avoid entering into a position without the worry of not getting executed on one of the legs.
Lime Trader is designed to make multi-leg options trading more accessible. The platform executes simultaneously to reduce execution risk. Lime Trader’s position management features let you select and open, close or roll option legs. The position views provide rollup calculations by strategy and underlying assets to track your portfolio’s P&L and Greek values.
Stock symbols and company names displayed are for illustrative purposes only.