Do Iron Butterflies Need to be Adjusted?

This post will be a quick diversion from the iron condor posts.  You may have noticed on my Twitter feed that I have been running backtests on iron butterflies, straddles, and strangles, using a range of entry and exit criteria.  Today we will take a look at some statistics of a medium term, 43 days to expiration (DTE), iron butterfly on the SPX, to see how different wing widths and exits impact the P&L of this options strategy.

First let's look at the equity curves for some different approaches for picking the wing widths of these 43 DTE SPX iron butterflies.

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The chart above shows the equity curves for four different wing widths of iron butterfly (50 point, 75 point, 100 point, and 125 point).  The solid lines are the equity curves for a "no touch" iron butterfly ...these trades are simply entered at 43 DTE and carried to expiration with no adjustments.  The strategies associated with the dashed lines are either carried to expiration OR exited with a profit of 10% of the credit received.  The 10% exit variations perform better than the iron butterflies that are carried to expiration.

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The chart above shows the equity curves for the SPX iron butterfly, where the wing widths were set at 5% of the value of the SPX on the day of entry.  I tested a number of different dynamic exits against this strategy, and I've included some in the chart above.  If you've been following my iron condor posts, you will recognize the terminology in the legend of this chart.  Regardless of the exit approach, all variations were unprofitable except for the ML40%:25 dynamic exit...and just barely!  The variations that were carried to expiration performed the worst.

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The chart above shows the equity curves for the SPX iron butterfly, where the wing widths were set at the 20 delta strike.  For consistency, the same dynamic exits shown in the 5% wing width chart are shown in the 20 delta wing width chart above.  Some of the dynamic exits combined with the 20 delta strike location performed very well through 2008, but have since been fairly flat.  The 20 delta equity curves look better than those in the prior two charts, but their P&L has either fluctuated wildly or been flat...not very tradeable in this form.

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The chart above shows the equity curves for the SPX iron butterfly, where the wing width is set at a fixed size of 100 points.  Again, for consistency, the same dynamic exits are shown in the chart above as in the prior two charts.  Not surprisingly, the variations that were carried to expiration performed the worst.

The equity curve charts show a range of different wing width approaches, from static point based. to dynamic delta and percentage based.  Regardless of the approach for setting the wing width, there is a general trend of dynamic exits improving the P&L relative to the variations carried to expiration...this is one take away.  Another take away, at least for me, is that none of these 32 variations appear tradeable using the rules that were tested.

Next, let's take a look at the trade metrics associated with the four equity curves above.  In the first section of each of the tables below (the first three rows), the total P&L in dollars is shown, as well as the percentage of winning trades and percentage of losing trades.  The second section shows the max risk / margin requirement.  The next two sections show how many trades had the market move to their long put or long call, and the metrics associated with these "touches".

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Here are a couple of points that I noticed from the trade metrics tables above:

1. Trades that were either exited at expiration or exited with a profit of 10% of the credit received, had the highest percentage of winners (73% - 83%)

2. The total dollars lost in a trade where the market touched either the long call or long put, far exceeded the dollars won in trades where this occurred...this is important!  Price reversion did not occur.

For example, lets look at the trade metrics table above, for the 5% wing width iron butterfly. The sixth column of data (43 DTE (5pt-gr) (1/1) (25:25)), shows the metrics for the 5% iron butterfly that is either exited at expiration, OR exited for a loss of 25% of the credit received, OR exited at a profit of 25% of the credit received.  In 19 of these 91 trades, the market touched the long put of the iron butterfly, and in 17 trades the market touched the long call of the iron butterfly.  Of these 19 trades where the market touched the long put, 12 went on to become losers, losing a total of $13,535.  The 7 that became winners only added $7,443.  Of the 17 trades where the market touched the long call, 14 went on to become losers, losing a total of $14,798.  The 3 that became winners only added $4,080.

In nearly all of the 32 strategy variations tested, this pattern plays out...in trades where the market touches either the long call or long put of the iron butterfly, the majority of these trades tend to become losers.  In addition, the total losses associated with these "touch" trades far exceeds the dollars won in these same trades.  If the market moves to your long strike, the market tends to continue it's movement in the same direction.

I think the equity curves and tables above should give you the information needed to answer the question in the title of this blog.  Based on a range of wing widths of iron butterfly, the data seems to suggest that 43 DTE SPX butterflies should be adjusted rather than managed as "no touch" trades.  In addition, the long strike location can be used as one input into your adjustment rules....say add another butter when the market gets within (or beyond) some percentage of the long strike location.

This post took much longer than I anticipated, but hopefully it provides you with some new ideas.  In the next post I will get back to the 66 DTE iron condor options strategy posts, specifically looking at the 16 delta short strike...this strike is interesting!

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