Today the SPX is down 13 points to $1680, down almost 1%. IBM is down almost $1 or about 1/2 of a percent. IBM is trading at $184 as it moves south with the market today. The 12 month low is a tinge under 182, and it has traded as high as $216 the last 12 months. The stock is at bottom of range and implied volatility has popped a bit. What is a good strategy for the upside if I think IBM will bounce back a bit and implied volatility will drop at least 1 point?
Strategy? Directional Butterfly in the Calls
Mechanics? Buy 1 October (10/18/13 expiration) 185 call, Sell 2 October 190 Calls, Buy 1 October 195 Call. Net Debit .90 ($90). Would I pay .95 ($95) if I had to? Sure. If I cave in from .90, try .92 first before .95. Prices exclude commissions.
What’s my thinking and plan? I think IBM can bounce to $190 in next 2 weeks. I’m not saying it will be there in 2 weeks, just that it will visit $190 , that’s what I’m looking for. Do I need IBM to hit $190 to make money? No! Theoretically, what might this spread be trading at in 1 week if stock only made it to $186? In 1 week, this spread should be trading around $1.25 with IBM at $186. If IBM reached $188 in 1 week, this spread could be trading at $1.40, up around 50%! ( remember we paid $90 ). If the implied volatility decreases on a bounce upward, which it probably will, I will make more.
Plan for the trade? This is a speculative trade and I am looking for a 40-50% return for my initial cost of 0.90. My Maximum Loss allowable would be the same. Since it’s only $90 for every 1 by 2 by 1 contracts I enter into, what if I did a little larger size? I would always Paper Trade then trade small for a while as I get comfortable with the trade. If I did it 3 times , it would be 3 by 6 by 3 contracts. If I did this trade 10 times, it would be 10 by 20 by 10 contracts and the cost would be 10 times .90 or $900.
How would I execute this trade? In one trade. I wouldn’t split up parts of the butterfly.
Why do I like this trade? This is a great directional trade in my opinion because it allows retail investors the opportunity to trade expensive stocks or indexes for a fraction of the cost of a long option or even a vertical spread!
Have a great day! Just started a new online class, Check out Sheridanmentoring.com for more information. Dan Sheridan