by John Kmiecik | November 27, 2013 6:59 am
Many traders (including yours truly) will be glad this holiday week is over. Don’t get me wrong, I love the holidays for family get-togethers and great dinners, just to name a few reasons. But short weeks with less participation from traders often make for erratic markets. This trade idea on Chinese Internet media company Sina Corp. (SINA) looks a little farther out from this hectic time.
The trade: Buy the SINA Dec 80/85/90 Call Butterfly Spread (buying the Dec 80 call and selling two Dec 85 calls and buying the Dec 90 call) for 85 cents or less.
The strategy: The maximum potential profit for this trade is $4.15 if SINA is trading right at $85 at December expiration. The long 80 call option would have $5 worth of premium and the other options would expire worthless. Then the cost of the trade is subtracted ($5 – $0.85). The maximum loss is 85 cents or what was paid for the spread if SINA stock is trading below $80 (all options expire worthless) or above $90 (all options would have to be bought or sold) by December expiration. Breakeven is at $80.85 and $89.15 at expiration based on a cost of 85 cents.
The rationale: A directional butterfly spread normally is a speculative trade because the trade profits from a directional move at a particular time. Maximum profit is earned as close to expiration as possible. The benefits of buying a directional butterfly over long calls, for example, is time decay. If the stock trades sideways, a long call will lose more premium vs. a butterfly that has a smaller theta, which measures time decay of options. If the move doesn’t come until just before expiration, the butterfly will benefit more than a long call depending on the strike and expiration.
Another reason this trade idea on SINA looks inviting is because of the risk/reward ratio and breakeven points of the trade, both of which are arguably large.
Click to Enlarge Taking a look at the chart on Sina, a move higher is expected. SINA stock gapped up after an upbeat earnings report earlier this month, and after closing several times around $85 (maximum profit area), shares subsequently traded lower.
SINA stock has come down to a previous pivot level where it reversed and moved higher. This is sometimes referred to as a double-bottom and is a possible reversal sign.
For this trade idea to work, Sina needs to repeat that price action from earlier in the month and test the $85 area, preferably right around December expiration.
As of this writing, John Kmiecik did not hold a position in any of the aforementioned securities. Get a free trial of John’s live options trading room here.
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