When an OPTION STRATEGIST considers an option Butterfly position, they usually focus on the market-neutral outlook it provides. The trade is typically entered by selling two at-the-money (ATM) options for every one bought above and below the at the money strike sold. (
1-2-1
). Using these points of entry, the OPTION STRATEGIST is taking on a neutral opinion and looking for the underlying to stay near its current price.
In some circumstances, we may have a price target in mind where we expect the underlying to move away from its current price. If we place a butterfly spread near a price target, we can establish a more probable profit zone with lower risk by shifting the butterfly?s body out-of-the-money (OTM) using wide strike prices on the wings. Out of the money butterflies cost less than buying calls or puts outright or even buying VERTICAL SPREADS. This can offer significant profits with lower risk.
Keep in mind, a DIRECTIONAL BUTTERFLY can be used in either direction depending on the price target, we can do this on the CALL side or the PUT side.
For the purpose of this article I will take a BULLISH OPINION on GOOGLE using CALLS. With GOOG trading at around 489, we will illustrate using a price target of 500 using STRIKES 10 points apart.
|
STRIKE |
PL |
|
POSITIONS |
|
511 |
(1,700)
|
|
10 / 490 CALLS @ 7.50 |
|
510 |
(1,700)
|
|
-20 / 500 CALLS @ 3.70 |
|
509 |
(700)
|
|
10 / 510 CALLS @ 1.60 |
|
508 |
300 |
|
|
|
507 |
1,300 |
|
DEBIT $1700 |
|
506 |
2,300 |
|
|
|
505 |
3,300 |
|
|
|
504 |
4,300 |
|
|
|
503 |
5,300 |
|
|
|
502 |
6,300 |
|
|
|
501 |
7,300 |
|
|
|
500 |
8,300 |
|
GOOG |
|
499 |
7,300 |
|
|
|
498 |
6,300 |
|
|
|
497 |
5,300 |
|
|
|
496 |
4,300 |
|
|
|
495 |
3,300 |
|
|
|
494 |
2,300 |
|
|
|
493 |
1,300 |
|
|
|
492 |
300 |
|
|
|
491 |
(700)
|
|
|
|
490 |
(1,700)
|
|
|
|
489 |
(1,700)
|
|
|
|
488 |
(1,700)
|
|
|
|
487 |
(1,700)
|
|
|
|
486 |
(1,700)
|
|
|
|
485 |
(1,700)
|
|
MAX GAIN = 8300 |
|
484 |
(1,700)
|
|
MAX LOSS = 1700 |
|
483 |
(1,700)
|
|
|
|
482 |
(1,700)
|
|
PROFIT
RANGE
|
|
481 |
(1,700)
|
|
492 - 508 |
|
480 |
(1,700)
|
|
|
As we can see, based on the PRICE TARGET this trade offers an attractive RISK/REWARD. As always, the OPTION STRATEGIST can vary the components by tweaking the strikes based on his/her objective and comfort level. Adjustments can be made for greater profits by simply stretching out the wings and using the 480/500/520 STRIKES. This of course, will certainly change the structure by increasing the opportunity for greater profits, keep in mind it will also increase the RISK significantly.
In my next article, we will take the same price target and illustrate how the 480/500/520 BUTTERFLY will play out.
Frank Kneipher
FKPRINTS@YAHOO.COM
