Summer Is Butterfly Option Season

As summer approaches and as the recent rally has stalled, I'm sure we'll start hearing calls for people to start employing the "Sell in May and go away" approach to investing. While this adage usually refers to selling some stock holdings to lessen a portfolio's exposure, it is often also applied to options.

But a big distinction between lightening your load of stock holdings and establishing net credit option positions is that the former reduces risk, allowing you to enjoy your long summer weekends. Selling premium on the notion that volatility will remain muted can carry considerable risk and requires constant monitoring.

Given that implied volatility levels have drifted down to their lowest levels of the year, but both headline and company-specific risk remains high, employing premium selling strategies such as straddles on the hopes that the market or a stock will be range-bound don't strike me as particularly attractive.

On the other hand, buying options, whether it be puts or calls, can result in losses by a thousand ticks of the clock as time decay erodes the value of the options.

June is notoriously a bad month to own options, since earnings season is over, and the Memorial Day holiday effectively dials time forward by lopping off a day of trading (or two or three, given that many people take an extra time off) and therefore time premium.

Floating Into a Butterfly

Those who are looking for a more hands-off or less stressful way of way to stay involved might want to consider using butterfly spread strategies. A butterfly spread is essentially two vertical spreads stacked on top of each other with a common middle strike price. It a net debit position, meaning it is a position that is purchased, and, unlike a credit position, if the options expire worthless, it will result in a loss. But the loss is limited to the cost, which is usually minimal, meaning the strategy offers a very attractive risk/reward profile.

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Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He appreciates your feedback; click here to send him an email.

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