The Put Butterfly – Illustrated with Nordstrom

There are many different strategies that I use with options and over the next few weeks I will continue to go through some of them to help explain the strategy and how it can be used to access market with controlled risk. The first in this series last week was the Call Spread Risk Reversal (link below). Today’s is the Put Butterfly.

Put Butterfly

This strategy consists of buying one Put Option, selling 2 lower Strike Put Options and then buying a third lower Strike Put Option, to create the Butterfly. The Strikes of the 3 Puts should be equal distance from each other. In this way you are essentially long a Put Spread with the higher and middle strike Puts and also short a Put Spread with the middle and lower strike puts, both of the same width. Because of this symmetry, buying Butterfly’s requires no margin. The profit is also capped to the width of the Put Spread, less the cost, and reaches its maximum at the middle Strike Put, but the risk is also limited to the premium paid. Despite limited risk and reward these trades can still have reward to risk ratios at the maximum payout of 5:1 or more.

This options trade is ideal for short term events where there is a good degree of certainty about where the price may end up. For instance a low volatility stock as a short term earnings play where the implied volatility suggests a move that will remain within support and resistance levels. Lets look at an example from a trade we took last night on Nordstrom, $JWN.

The chart above shows Nordstrom, $JWN just after 2pm Thursday. This is a bearish looking chart and was corroborated with the weekly chart (contact me if you would like details). Support lower comes at 49 followed by 48, 47 and 44.70. The trade we did was a November 49/47/45 Put Butterfly. Buying the November 49 Put selling 2 November 47 Puts and then buying the November 45 Put. At a cost of 30 cents it is in the money for a range of 45.30-48.30 at Expiry and yields a maximum profit of $1.70 at 47. Why did we do this trade? The options board showed an implied move of $3.20 or 6.5% from the at-the-money option. This created a tight range of 46.4-52.8, just below the previous high. For the tight range the Put Butterfly is a good way to cover the range at a low cost, and since the resistance at 47 was very near the bottom of the implied range at 46.40 the 47 Put as the center strike was perfect. The stock did drop after reporting to near 47 in the after hours market and rebounded to end that session at 48.40. We may close this trade this morning if it moves back lower after the open or at any time over the next week on a continued weak looking chart.

The Call Spread Risk Reversal – Illustrated with Leap Wireless

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The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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