17 lines
1.0 KiB
Plaintext
17 lines
1.0 KiB
Plaintext
Directional Butterflies
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Trading a butterfly can be an excellent way to establish a low-cost,
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relatively low-risk directional trade when a trader has a specific price target
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in mind. For example, a trader, Ross, has been studying Walgreen Co.
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(WAG) and believes it will rise from its current level of $33.50 to $36 per
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share over the next month. Ross buys a butterfly consisting of all OTM
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January calls with 31 days until expiration.
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He executes the following legs:
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As a directional trade alternative, Ross could have bought just the January
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35 call for 1.15. As a cheaper alternative, he could have also bought the 35–
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36 bull call spread for 0.35. In fact, Ross actually does buy the 35–36
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spread, but he also sells the January 36–37 call spread at 0.25 to reduce the
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cost of the bull call spread, investing only a dime. The benefit of lower cost,
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however, comes with trade-offs. Exhibit 10.5 compares the bull call spread
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with a bullish butterfly.
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EXHIBIT 10.5 Bull call spread vs. bull butterfly (Walgreen Co. at $33.50).
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