Think outside the box... Most retail costumers buy butterfly's dirt cheap hand over fist trying to hit it big on these low cost trades. The real question most should inquire about is why are butterfly's so inexpensive?? They have very low probabilities of success!! The standard butterfly is simply "taking a shot" and should be utilized and viewed this way. So what now for the butterfly?? Do we abandon our long shot altogether?? Not likely. The butterfly can be used quite readily but we just need to tweak it to create some positive theta decay while taking a shot. A butterfly for a credit?? Enter the Monkey-fly (and yes we could not think of a better name for it, but we are amused). Take the traditional butterfly, seemingly harmless and easy to define the total risk. Step it up a notch and let us examine selling a vertical spread to finance the purchase of our butterfly. Take a look at the example below with the SPY trading at $82.65 we have created a define risk Monkey-fly with an embedded $1.00 wide vertical spread.

Ok so there is risk in the vertical spread we are embedding but as with any out of the money short vertical there is also a high probability of success along with a positive theta. Now let's break this Monkey-fly into its synthetic components. The butterfly component of the trade is long 1 x 84 calls, short 2 x May 85 calls, long 1 x May 86 calls. The embedded vertical spread is the May short 1 x May 86 calls and long 1 x May 87 calls. These two trades placed separately would result in 5 separate legs whereby increasing transaction costs. Combining the spreads has reduced the trade to 3 legs but as with all multi-legged spreads you must factor in the increased transaction costs associated with each trade. Furthermore, placing the Monkey-fly as one spread rather then legging also reduces "leg risk" in what has been an extremely volatile market. What it imperative to understand about this convoluted butterfly is again there is a vertical spread embedded and the trade carries risk. This Monkey-fly example with its embedded short call spread also carries with it negative deltas and therefore a bearish market sentiment.

Let's look at the facts: We have embedded a short May 86 call/87 call vertical for a +.35 credit. The spread is $1.00 wide vertical of which we have already received a +$0.35 credit therefore, the maximum potential risk in the trade is -$0.65. Our break-even point in the trade is the short May 86 calls plus the +$0.35 credit received or $86.35. (Remember we are embedding a short vertical spread therefore we are synthetically short the 86 call strike.) Maximum profit potential on the trade is achieved at or near expiration if the underlying SPY shares fall directly in the central 85 strike of the Monkey-fly. This would produce a $1.00 profit plus the +$0.35 credit received for placing the spread totaling +$1.35. The ideal landing spot for the SPY come May expiration is obviously $85.00 but if the SPY's fall anywhere under $86.00 we are still profitable. Based on currently May implied volatility there is approximately a 65% probability of the SPY's falling under $86.00 by May expiration. Stay tuned because there is more to come on embedding spreads to finance our trades.

thinkorswim, Inc. and its registered employee, Don Kaufman, do not solicit or recommend any form of trading in the individual stocks (or their derivatives) mentioned above. Please do careful, independent research before investing any money as well as weigh the possible consequences on your particular financial situation before doing so. The risk of loss may be substantial.