Paragon Options – The Butterfly Effect on Gold Futures Options

Paragon Options – The Butterfly Effect on Gold Futures Options

Paragon Options is a service that focuses exclusively on futures options. By doing so we are taking advantage of superior premiums compared to stock options and asset diversification offered by futures. Paragon Options is a directional options service that will focus on Metals, Energies, Bonds, Currencies, and Commodities. This service will launch on June 25th.

Managing The Gold Futures Long Trade

We’ve been preoccupied with yesterday’s Paragon Options webinar for much of this week so this week’s post is a bit of an afterthought, but we wanted to talk more about the long gold trade because it is an elegant trade, and we have converted the original position to a butterfly by adding a long call yesterday.

The trade is significantly up despite Gold Futures having move against us since we entered the trade and, by converting this into a butterfly, we have turned this into a long play on which we are now guaranteed at least a modest profit, that requires almost no margin, and that could still deliver us a large profit if GC moves our way.

This post follows on from the previous post on this trade posted on 3rd May. You can see that post here. We also discussed this trade in detail in yesterday’s webinar, and you can see the recording of that on our May Free Webinars page.

Gold Futures Options Trade Setup

+1 Jun/Aug 1390 Calls

We have added to our short 2×1 ratio gold futures option call spread by purchasing a Jun/Aug 1390 call over the top of the existing structure.  This has had the effect of turning the spread into an option strategy known as a long butterfly.

A long butterfly carries no risk over the premium paid for the position.  In effect we have legged into this trade by starting off with a 2×1 ratio spread and adding a further leg here.

There are two main reasons we have done this.  The first is that we still like Gold futures higher from here even though we have so far been wrong with our bullish call and the drop gives us a chance to purchase this additional leg very cheaply locking in a zero risk trade.  The way the 2×1 was constructed meant that it had a negative delta as we were concerned about a drop in Gold futures first as mentioned in the previous blog post.

This drop has materialized although we have seen a bigger fall than we expected, however, the structure of the trade has worked nicely and even though overall it is a bullish trade it has made money from its negative delta.  Moving from a starting credit of $1.30 to $1.00 positive. Meaning we are up $2.30 on the position.

This has enabled us to add the additional 1390 call for a cost of $1.00 and has meant that we now have a free upside play on Gold futures, with an overall set up cost of $-0.30.

Another effect adding this leg has had which should not be underestimated is the dramatic reduction in the margin required to maintain this position.  The margin has fallen from $5678 per 1 lot to only $52, this reflects that the position now carries no risk other than the cost of set up. This means we have freed up a huge amount of margin which we can deploy elsewhere within the portfolio and shows how we are constantly looking to maximize the efficiency and risk management of our positions.

I have added a diagram of the P&L of a long butterfly below to give you an idea of how the position works.

Here, the ATM part of the butterfly (B) would be the 1360 strike and our maximum profit.  The newly added leg at 1390 is (C) and you can see that at that point the position incurs no further loss, in fact, the loss at (C) is the same as at (A) showing that the risk is indeed limited to the cost of set up.

We now have a positive delta of 7 on this butterfly so the position will decrease in value if Gold futures continues to fall, however, we can’t lose anything as we set it up for a credit overall and so we would just net the credit on expiry.

Summary

We have been able to add a very cheap leg to our already existing position, locking in a free upside play with zero risk, as well as freeing up a huge amount of portfolio margin which we can use elsewhere.

This will be a common theme with our positions in that we do not just set and forget them, they are constantly monitored and tweaked as the market demands.

About the Author

shjackcharts
I Chart Therefore I Am

2 thoughts on “Paragon Options – The Butterfly Effect on Gold Futures Options

  1. Erich - May 25, 2018 at 4:41 pm

    Hi Stan,

    Where is the latest post with your /ES trade that you mentioned on the daily update?

    Thanks
    Erich

    Reply
    • Stan Nabozny - May 27, 2018 at 1:43 pm

      Hi Erich – Jack is working on it, should be posted shortly.

      Reply

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