Skip strike unbalanced butterfly spread in EXC

Posted by: Admin: "The Vol_Trader"  //  Category: Volatility Trades

Sorry for my absence lately.  I’ve been consumed with starting two new small businesses.(Not trading related.)

Today, I’m back with an interesting trade I will call an ‘unbalanced or ratio skip strike butterfly spread’.

The trade is in EXC. My trade logic is:

EXC announced earnings that disappointed.  The stock went down and has continued it’s downward move for the subsequent two sessions. (Trade was placed yesterday 10/26/2010 and it’s down again today as of this writing).  The daily chart is below: (click any picture to enlarge)


You can see a clearly bearish trend over the past year.  The recent down move has broken down below support since mid Sep. 

Interestingly, IV did not move up with this large point decline.  The below six month chart of 30 and 90 day volatility (source: Live Vol Pro) shows that IV only moved up slightly into earnings and was (and still is) well below the historic implied volatility for the past six months.


Below you can see the recent large move down without a corresponding pop in 30 and 90 day implied volatility.


With all of this info I’m predicting a further move to the downside in EXC and an increase in implied volatility over the next 90 days.

The trade: +10 Jan $47.50 puts / –30 Jan $44 puts / +40 Jan $39 puts

The profit and loss chart look like this (Source Think or Swim):


EXC is currently trading at $40.60 as of this writing.  At expiration this trade is profitable above $41.86 and below $36.15. 

Below you can see the chart of vega vs. underlying price.  The trade is very long vega at the money and down to $36ish.  It is short vega above $44.


As I always say, I’m entering trades like this to take advantage of the implied volatility in addition to picking direction.  If the underlying moves up and I was wrong I will become long theta and can wait for decay to work in my favor or get out with a small loss.

If the underlying moves down quickly I’ll profit from my short delta (direction) and from my long vega as implied volatility increases.  This is the result I’m looking for.

My risk in this trade is a slow move to the downside with decreasing implied volatility.  My risk is defined to a maximum at $39 at expiration.  Luckily, markets tend to move down quickly and up slowly. 

Exit plan:  I’m hoping to get a quick downside move prior to expiration and take profits.  An explosive move to the downside would work very well.  If I am given a profit I will sell off a few contracts at a time taking profits.  If the underlying moves up I will likely take a small loss to a small profit depending on what volatility does.  Since it is already low on the charts the volatility may not drop much and I’ll have a small profit.

Thanks for reading. Please send comments.  I have some comments from my last post that I’ll address in the next few days.  Again, sorry for my absence…. – Lawrence

PCP – how I adjust a long stock position

Posted by: Admin: "The Vol_Trader"  //  Category: Trade strategy

There’s many articles written on how to “repair a broken stock” out there.  Click here for a good recent example from The Motley Fool.  They instruct you to buy one ITM call (one for each 100 shares you’re long), and sell 2 OTM calls.  The only problem with this strategy is that it still leaves you with lots of downside risk.  The above mentioned article states if the underlying goes down all options expire and you lost just your commissions, try again and unfortunately your underlying’s value has lost even more.

I like to protect myself a little more than that to the downside, even if I’m bullish (why else would I own the stock?).   The easiest way to protect a stock from downside risk is to buy a put.  Buying a put makes me short theta which I hate.  I feel there is only one thing that is guaranteed in the market, time will pass.  I want to be long Theta whenever possible.  So, how do I offset the cost of my put and get short theta?

First I want to make my predictions as to where the underlying will go. Second, and equally important, I predict what IV will do.

Looking at the daily and weekly charts (click any picture to enlarge) with volume profile, I’m predicting PCP will stay in a range with support at 102 and resistance at 120.  Earning are on 7/22/10 and historically, it has not made major moves after earnings.  Volatility has also been in a range for some time and historically, Vol drops but not much after earnings. 



Using the above predictions, I want to create a trade that profits if PCP stays in a range, and if Vol stays the same or drops.

Here’s the trade. 

  • I own 100 shares of PCP, currently trading at $107.79. (My price is $121.40)
  • +1 Sep $105 put.
  • +4 Sep $120 call.
  • -5 Sep $110 call.

The P&L looks like this for the long stock (obviously) below:


The P&L looks like this after I added the options, below: Notice that this trade is ‘profitable’ in the range that I anticipate.  If the underlying stays in the range as I predict, my trade that is currently around -$1,400 will be -$300.  Then in Sep, I can put on a similar trade again as long as my predictions have not changed.  I now have a limited risk trade that I can manage or stop out if PCP should rally hard.  Synthetically, you’ve created a broken wing butterfly (long stock and long put is long call +1 $105call / –5 $110 call / +4 $120 call).


Also, the Vega is pretty neutral.  At first glance at the chart of Vega it looks exactly the opposite of what you want.  It’s short Vega to the downside and Long Vega to the upside, however, with further examination, you’ll notice the largest value for Vega is +/- only $26.  See below:


As usual, I’ll keep you posted as to adjustments and management. 

* Here’s an idea for discussion based on the above.  You can use this strategy to put on a bearish synthetic broken wing butterfly and own shares of your favorite dividend paying stock.

*this is not a trade recommendation, education only.