OptionPundit

Category: Butterfly spread

  • A Broken Wing Butterfly for Trading Russell 2000

    How do you trade downside, while still not losing much if the underlying continues to go up?

    This is a question I am often asked by many. There isn’t any better instrument than options, that I know of, to trade such a scenario. Albeit, the answer actually depends on how much do you understand options.

    In this post, I will take an example of Russell 2000 (Ticker : RUT) using real-time prices (as of this writing)-

    Our hypothetical scenario (not what I think) : I think RUT is done going up, but I can’t be sure. There were many times when I thought this will happen but it didn’t, resulting in loss of my trade and capital. On the other side, there is high likelihood that it will drop. Based on my best estimates, I think it will touch 200dma, in 3-6wks, which is around 1150. So what can I do? Well there are many way to trade this scenario, but one of the scenario, I am going to use is utilizing BUTTERFLY SPREAD.

    Here is how –

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  • Trading Directionally Using Butterfly Spread

    Options is a versatile asset class and offers a lot of opportunities. Though most people think options are risky, if understood and done properly options can offer a wide variety of choices for retail traders including consistent monthly income. This post exhibits a powerful strategy for being long using Butterfly spread that limits the risk dramatically while increasing yield significantly.

    Take directional trading for example.

    Traditionally, a retail trader had only two choices for a directional view i.e. a) to either buy shares (if you are bullish) or b) short shares (if you are bearish). I am leaving out other methods that were not readily available for retail trades. The capital requirements were huge for such trades especially for high price stocks.  For instance- If you were to go long Apple Inc. (AAPL), you will have to buy 100 shares for $42,700 (@427/share LMP). Similarly if you are bearish, shorting 100 shares of AAPL will require substantial capital too. Traders later started using Options to leverage.

    Let me explain the two via an example-

    Outlook Assumption: You might be of the view that AAPL will touch 500 by Jan 2014 expiration (vs. $427 closing price).

    • Your gains will be ($500-$427=$73) a total of $7,300; a large sum but still a respectable +17% gains.
    • If However, you would have traded it using Jan 14 475 call options, your cost will be $1,270 and assuming AAPL does closes at 500 by Jan expiration, your gains will be ($500-$475=$2,5) a total of $2,500 or +96%.
    • If however, the price is below $475 by Jan-14 expiration, you would lose all, limiting to maximum loss $1,270 in case of call option and $42,700 in case of 100 shares, if AAPL were to drop to $0.

    Is there a third alternative?

    This is where a Butterfly spread fits in. Let me show you how:-

    The butterfly spread is a neutral strategy that is a combination of a bull spread and a bear spread. It is a limited profit, limited risk options strategy. There are 3 striking prices involved in a butterfly spread and it can be constructed using calls or puts or both.

    So for our case, here is the butterfly spread, using all CALLs:

    • Buy to Open 1 AAPL Jan-14 475 Call
    • Sell to Open 2 AAPL Jan-14 500 Call
    • Buy to Open 1 AAPL Jan-14 525 Call
    • Total cost: $180 only

    Here is how the risk reward of this trade looks like.

    AAPL Buttlerfly Spread
    A Long Call Butterfly Example on Apple (AAPL)

    How to read this chart:

    • This trade will make maximum profit of US$2,320 (that’s +1188% !) assuming AAPL is at exact $500 on Jan-14 option expiration.
    • This trade will still be nicely profitable if AAPL is in between $476.8 and $523.2. That’s almost $50 range.
    • The trade can’t lose more than $180 even if AAPL goes to zero.

     

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    It sounds too good to be true, so what’s the catch:

    1. Those profit figures will result in these gains, if and only if AAPL is between those strikes in Jan. If AAPL is within that range before Jan expiration, the gains will be smaller.
    2. Complete loss will occur only if AAPL is outside the range on Jan-14 expiration.
    3. Similar to buying share or a call option, this trade will result in loss if AAPL drops. The gains be smaller vs. if you had purchased call.

    Bottom-line: So why should I think of trading butterfly spread?

    When you have a directional view but you want to limit your exposure.

    If it is timed properly, Butterfly can result in very high gains in a very short period of time for a limited risk.

    Please don’t start investing right away using Butterfly Spread. Though this is a beautiful and very powerful strategy but still there are many things to consider while structuring a butterfly spread. Paper trade it, evaluate it to see how it fits your trading style.

    Should you have any questions,  you may also ask me your questions at this e-mail address->ask@OptionPundit.com . I will be glad to answer your questions.

    Profitable Trading, OP

  • A Bearish Broken Wing Butterfly on Russell 2000 RUT

    The Jackson hole  2012 surprise is over. You may want to either read numerous websites to find out what Chairman Ben thinks (as per their conclusions) or read the speech text yourself to draw your own conclusions.

    As of this writing, markets are rallying (though pulled back from the intraday high). For now, at least, Russell 2000 (RUT) is not participating in the rally. And based on charts patterns that are playing out in RUT, I am taking a slightly bearish position using next weeklies that expires next week.

    The trade is structured using a Broken Wing Butterfly and is done for a $2.50 debit.

    • Buy to Open +1x RUT 805 Put
    • Sell to Open -2x RUT 790 Put
    • Buy to Open +1x RUT 780 Put

    Total Debit- $2.50/ Using Weeklies that expires next week.

    Here is the risk/reward profile for the trade-

    RUT Broken Wing Butterfly

    This trade will start to make money starting now in case RUT pullsback. However, based on expiration day risk/reward profile, the trade will start to make profit only when RUT is below 802.5. Profit quantum will depend upon RUT’s position next week. Essentially my outlook is that we will have a pullback (small or big I don’t know) either in the afternoon today (low probability) or next week. Via risking only $250/spread, this trade can make $250 to $1000/spread depending upon RUT’s movement. If RUT is above 802.5 by next week, this trade will lose all.

    My target is roughly +50% profit or loss.

    Disclaimer– As of this writing, I am already in the trade but I may close anytime. Pls do your due diligence before investing and invest only what you can afford to lose.

  • Apple Computers (AAPL) Earning Trade +139%

    The big news today is Apple Computers’ (AAPL) miss on earnings. Who could have thought that they will miss. I certainly didn’t. Yesterday I shared a brief post on how we played Apple (AAPL) earnings in addition to a few other that I highlighted in that post.

    Basically, for AAPL,  there were two scenarios we started with-

    1. Gap-up and then fade throughout the day or
    2. Gap down.

    Since we were taking a contrary approach as mentioned in the post, we also wanted to maximize the yield without risking a lot of capital. Options were pricing a $20 move so we structured a butterfly  $400 strike. AAPL missed and stock dropped to $400. The Butterfly Spread gained +139%. A quick exit. If AAPL rebounded, all these gains would have vanished before I could have even realized.


    I selected JNPR, CREE and BLK with bearish bias but since I couldn’t find good risk/reward ratio trades, I opened none. Howver, based on last check, all 3 are down. JNPR -1.2% (flat), CREE -8%, BLK -4.5%

    Another earning play was- ISRG is a loss @ moment. The 340/350/420/430 condor was sold (paper trade) for $4.70. But right now it can be purchased to close for $5.30, thus a 10% loss.

    Final trade I mentioned in the blog post was FCX. I structured FCX trade via bearish verticals and closed at the open for +3.6% gains. I exited FCX quickly as they announced good set of numbers.

    Pls don’t be tempted by these spectacular returns. Even though these looks nice gains,it could very well be a 100% loss and therefore capital allocation is The key !!! Realizing that these are speculative trade with 50/50 chance of being successful, I invest only the amount that if lost 100% I can still sleep well. And of course, past success is no guarantee of future success when it comes to an uncertain environment like “earnings announcement”.

    The earning season is just gearing-up, more to come.

    Trade carefully, Trade profitably, OP

  • How to Play AAPL, ISRG Earnings

    It was first posted for the OPN Income Newsletter’s Members.

    Before you read further- please assume 100% loss upfront on whichever trade you take. Even though we might have win numerous times during the past (like GOOG recently), the chances of being correct are no better than flipping a coin. After screening all the tickers that are about to announce earnings after market close today and before market opens tomorrow (roughly 56 companies), here is my short list that I think will move and is worth spending sometime…

    AAPL, CREE, ISRG, JNPR, BLK and FCX

    – ISRG, I prefer to open a NOV 420/430 (Bear Call) and 350/340 (Bull Put), roughly $4.70 credit as of this writing. The stock is expected to move some $25 or so, but the kick here is IV crash which should benefit the condor. Based on my past experience opening of Oct options is easy but closing those is hard (for a good price).

    I think CREE, JNPR, BLK and FCX will not have pretty numbers. Either they will miss on earning, or revenues (most likely) and/or outlook. So I am biased for bearish trades. However, I couldn’t find good risk/reward structure. One needs to take risk here.

    – AAPL . I think they will announce “wonderful” numbers. No questions about it. But I think they are going to keep buffer in their pocket for the next quarter..for “what if”.. as that will be first quarter without SJ’s presence… there are two scenarios with AAPL.

    1. Gap-up and then fade throughout the day or
    2. Gap down.

    I think 2) is the most likelihood but I have not met a single person who ever shorted AAPL. In case of AAPL Oct 390/400/410 Bear Put Butterfly seems to be a better risk/reward. I personally wouldn’t open bullish positions on AAPL. If I will, I’ll probably play with weeklies after earnings announced and stock gaps higher [i.e. scenario 1). ]

    So bottom-line, I’ll assume 100% loss upfront and open a bear put butterfly on AAPL (debit $1.40 or so).

    Disclaimer- As of this writing, I was long AAPL Oct 390/400/410 Put butterflies.

    I shall update results post earning announcements.

  • OPNewsletter Oct’10 Up 7.7%, Gear-up for Earnings

    Undoubtedly GOOG earning play was a star trade generating over +800% gains in a day. It wasn’t sheer luck, we prepared ourselves for it. I shall share our exact trade after earning season is over as we plan to use similar strategies for AAPL and later for some more counters during this earning season.

    For the month of Oct expiration, OPN portfolio gained +7.7% on a maximum investment on 63.8% of the portfolio capital. This was our 32nd positive month out of past 34 months despite the worst financial crisis since the great depression. These results exclude P&L from speculative trades or trades mentioned on the OptionPundit blog or on InvesCafe. Here is the tally-

    – POT Income Portfolio: +45.9%
    – NDX iron Condor: +1%
    – Google OPN Portfolio: -16.7%
    – DIA: -2.08%
    – EWZ: +2.9%
    – IWM Portfolio: +10.9%
    – NKE Income Portfolio: +91.5%

    However, as I shared fills for my speculative part of the NDX iron condor trade, the trade generated +37% on the original base of $2K/ spread. That’s a magnificent returns considering that NDX moved over 200 points in one direction only and we didn’t do any adjustment since Sept 21.

    POT This was another star portfolio that generated excellent returns >+45% for less than 1 weeks holding. This wasn’t a speculative trade, but we let it run as the gains were accumulated due to rising IV while underlying didn’t move much. Google Income portfolio didn’t work out as I was expecting. I didn’t use any other combinations of backspreads/verticals/straight calls or puts (like I did in July) to keep it simple. I have shared my perspective about this portfolio. We played NKE earning as part of Income portfolio and within a day of holding this portfolio generated 91.5% returns.

    OP Speculative trades-
    These are bonus trades and are not part of the OPNewsletter and hence the P&L IS NOT part of OPNewsletter performance. We spend only a fraction of the overall capital for these trades and think of it is as accelerators (if we are right) but not as a dampner (if we are wrong). For instance, the Google trade delivered almost $1,500 for each $175 investment (for those who had $10K capital) that alone accelerates the capital gains by roughly 15% on the overall portfolio capital.

    We were stopped out of TLT, TIN was almost break-even. MOS generated +12 to +17% gains for one day holding, JPM generated from -55% loss to +100% profits; then we had great wins/partial loss on USDJPY pair via YUK calls

    OPBlog Trades– Gold, suggested on Sept 2 when it was around 1,250 and since then gold is up almost $100/ounce.

    Invescafe/Twitter Positions– I don’t send alerts for these trades as these are neither part of OPN nor bonus trade alerts and the key reason is because the trade time span can be from 5-10mins to hours and OPN members may not be able to reap benefits as by the time they receive these alerts, it will be too late for them.

    SIGA for +80% for 1 day holding, EQIX for > +50% profits, intraday,  TBT 30/28 BPS > +50% profits, TBT up over 10% since then, AXP +9%, AAPL, NFLX generated +150% and there are many more, check out my InvesCafe updates.

    While reviewing these results, pls keep the overall macro economic environmental context in mind. Sept (usually a bad month for markets) was a record month for S&P500 almost in 50years, a challenging month of non-directional income traders!!! The uncertainty is unusual, short interests are sky high. Yields on both Bonds and Stocks are almost at bottom. The expectations on returns are dismal at best.

    On the other hand, here at OptionPundit, OPN members/readers out of “stocks” since early April 2010, reminded them there is no such thing as “America Won’t recognize itself by the end of 2010” as projected by several top analysts and time and again talked about Feb Low, 10.3k and 10.7K for Dow. We are not taking unnecessary risk yet our returns are still respectable by almost any rationale standard.

    Trading is not about beating the market, always. No one can do that. Just like any other business, trading is a business and needs to be treated that way. We’ll have our shares of wins/losses. As long as we are humble and keep the “ego” at bay, learn from our mistakes and continuously sharpen our craft we’ll develop our own trading style. And if it is indeed a business then it’s not a destination but a journey through thick and thin of varying seasons.

    If you are not an OPNewsletter member and would like to sign-up, pls click here to sign-up for the waitlist as OPNewsletter subscription is open via invitation only.

    It was and still is, preserving capital is more important than a potential opportunity. Capital is for real, opportunity is “potential”.

    Congratulations on another successful month.

    Profitable Trading, OP