NFLX reports their quarterly earnings on Monday Oct 16th after the market closes. One interesting speculative play is to add a small out of the money call fly that can work if NFLX has an up move after the earnings release. Currently it looks like the expected move by the marketmakers is about $16. With NFLX trading around $196, I would enter the following trade:
OCT 20th Expiration
Buy 1 200 call
Sell 2 210 calls
Buy 1 220 call
Enter as a butterfly spread for around $1.50 per spread
The trade is profitable on expiration from about $201.50 to $218.50. Close at whatever profit you can get on Tuesday Oct 17th.
Earlier today I did a Live Butterfly Trade in a webinar for Ally Invest. Below is my 4 Step Risk Management Plan.
Step 1: The Set up: I did the Butterfly in SPX at about 11:25 am central today, Oct 9, with SPX around $2548. I bought 1 2520 Call, Sold 2 2550 Calls, and bought 1 2575 Call. I paid $12.15 Debit or $1215 for the entire trade. My beginning position Greeks are: Deltas -2 Theta 13 and Vega -107. Total Capital and Risk for 1 contract is $1220. The expiration is Oct 27 which is 18 days from expiration. Why did I do this? For monthly Income. How does this trade make money? The short options I sold , they decay quicker than the options I bought. ATM options decay faster than ITM or OTM options.
Step 2: Profit Target and Max Loss: 8-10% Profit. If I make around 8% on this trade this week, that’s about $100. So if I paid $12.15 debit, my goal is to sell this out for around $13.15 Debit. My Max Loss is 10-12% of the cost of the trade. So if I want to exit the trade at 10% loss, that would be about $120. So if the spread goes from $12.15 debit to around $10.95 debit I would enter a closing trade to sell out for 10.95 Credit.
Note: If beginner, don’t need to go to step 3. Can just take off trade for profit or loss from step 2. After you have done 10-15 of these Butterflies, you may consider using step 3 and step 4, a little more advanced risk management techniques.
Step 3: When to Adjust? 2535 on downside and 2560 on the upside.
Step 4: How to Adjust? Upside- Buy 1 Oct 27 2570 Call and Sell 1 Oct 27 2575 Call. Downside- Buy a Put in the Oct 27 Expiration that would reduce my long deltas close to zero.
The butterfly option trading strategy has many different structures and uses. The time bomb butterfly involves buying an out of the money all call or all put butterfly in the direction you think an underlying asset is going to trade.
Currently, there is a lot of uncertainty among traders as to which direction the market will head. This can be a good set up for the time bomb butterfly in the SPX. One example would be an all put butterfly placed in the Oct 6th expiration 31 days from now, that is centered at 2420.
While the width of the fly is up to the individual trader, using a 20 point wide wing could be structured as follows:
Buy 1 Oct 6th 2440 put
Sell 2 Oct 6th 2420 puts
Buy 1 Oct 6th 2400 put
This butterfly is currently trading at approximately 1.00 per contract. costing $100 for each 1/2/1 fly structure that is entered plus commission. If this butterfly at expiration is trading near 2420 this trade would net more than a 10 fold profit. It also has profitability from around 2440 to 2400.
If you have a bearish sentiment over the next month for the SPX this is an interesting trade to consider. I like using the time bomb butterfly strategy more than I like vertical strategies because of the low cost and possible exponential reward.
Consider one of these the next time you want to trade predicting market direction.
I also wrote an article about the “time bomb butterfly” that was published in the Modern Trader magazine which you can check out below.