by Karson Keith | February 8, 2012 7:35 am
In two recent articles, I detailed the short butterfly positions I took in GMCR and NFLX, AMZN and BIDU. And for good reason — this strategy has been generating near-20% returns on every trade.
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.
Right now I am looking at another short butterfly trade, this time on Panera Bread (NASDAQ:PNRA). Here’s the setup.
The credit on this trade was 65 cents as of the market close on Feb. 6. I am simply looking for a move of $4.35+ over earnings.
Short butterflies can be a great way to trade, but the other side of the same trade — the long butterfly — can also be a big money-maker in a different time frame. The trade setup is similar to the short butterfly, but this time you’ll be selling two at-the-money strikes, and then buying an in-the-money and an out-of-the-money strike. Once again, all “legs” of the butterfly will have the same expiration date.
Another key difference is that you will be paying a net debit to enter this trade. The long butterfly strategy benefits from time decay and lack of movement in the stock. Most investors make the mistake of trying to carry these into expiration and hope to get the max profit. This is a mistake because the butterfly position is most sensitive to movement when it is near expiration. In other words, you can lose a lot of money on the trade if the stock makes a small move at the wrong time. The key is to get into the trade with enough time left before expiration in order to be less sensitive to a move in the stock.
Right now, I am doing two long butterfly trades — in Caterpillar (NYSE:CAT) and IBM (NYSE:IBM).
Caterpillar is currently trading around $114. I will close the trade on Monday or Tuesday, Feb. 13 or 14. Or, if the stock makes a big move to the far strikes of the butterfly (i.e., toward the $105 or $120 strikes), I will close it down.
IBM is currently trading around $193. I will also close this trade on Feb. 13 or 14. Or, again, if the stock makes a big move to the far strikes ($180 or $200), I will close it down. The objective is to avoid the time frame when the position is very sensitive to a move in the stock.
To learn more about Karson Keith’s weekly options strategies, click here.
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