As I have shown you in my past articles, trading short option butterflies on the appropriate stocks before earnings can be very lucrative.
Even though earnings season is starting to wind down, there are still plenty of opportunities left for us to play for profits. In fact, I plan to do the same thing all over again in Baidu.com (NASDAQ:BIDU).
Remember, the short butterfly is an options trading strategy where you buy two at-the-money options (i.e., the body) and sell one in-the-money option and one out-of-the-money option. The trade is done for a net credit that you receive when you initiate the trade.
I also have another trade for you in Apple (NASDAQ:AAPL) today, and I’d like to share the details of those new trades with you in just a moment. First, let’s look at this BIDU short butterfly.
Trade #1 – Baidu.com
BIDU reports earnings after the close on Thursday, Feb. 16. I will be doing the following position on Wednesday before the close:
- Sell 10 BIDU calls $5 below the at-the-money strike
- Buy 20 at-the-money BIDU calls
- Sell 10 calls that are $5 above the at-the-money BIDU strike
All of these will be done using Feb. 17 expiration.
With BIDU trading at $140 a share, that would mean selling 10 of the $135 calls, buying 20 of the $140 calls and selling 10 of the $145 calls.
One thing to note is if the position becomes profitable by more than 30 cents before the close on Thursday due to rising volatility, then I will take it off the table and not even take the risk of holding it into earnings.
Trade #2 — Apple
There always seems to be big news surrounding Apple, and this week is no different, as the stock shot past $500 in yesterday’s trading.
And now, AAPL’s big volatility after its strong move higher presents a great opportunity.
I want to do the following forward ratio spread on AAPL:
- Buying 10 of the AAPL March 575 Calls
- Selling 20 of the AAPL March 590 Calls
I will do this on the March regular options expiration (i.e., we’re not using weekly options).
This can be done for a 35-cent credit.
Note that both “legs” of this spread have the same underlying asset (AAPL), plus the same expiration date (March 16). They have different strike prices, but the other difference here is the “ratio” — here we’re buying 10 of one strike price and selling 20 of a higher strike.
A “ratio spread,” then, is when you sell (or write) more options than you buy. Like the short butterfly, your aim is to collect more money on the short leg than you pay for the long side of the trade.
With this trade, we’re watching for the stock to go up. And this trade is safe all the way up to $605.
If AAPL does make a spectacular rally up to my bought strike I will simply close down the position early for a large profit, otherwise I will let the position expire worthless and keep the 35 cents.
This opportunity comes up from time to time when a large spike in volatility happens on an individual stock.