Butterfly Season in Options Land

It also means that maximum profits can't be realized unless the position is held until expiration. The right time to establish butterflies is when you believe the market may stay within a defined range. Currently, this can be defined in the S&P 500 by support at 1140 and the big, bad resistance at the 1200 level.

For example, with the S&P 500 trading at 1175, you could buy the July 1125/1175/1225 butterfly for a net debit of $14 per spread. The 1125 calls can be bought for $63, two units of the 1175 can be sold at $28 each, or a total of $56, and the 1225 call can be bought at $7 per contract. This gives the position a maximum profit of $36 if the S&P is at 1175 at the July 15 expiration. The maximum loss is equal to the cost, or $14, and will only be incurred if the S&P swings outside the 100-point, or 8.5%, range defined by the 1125 lower strike and 1225 upper strike of the position.

Kick Back, but Don't Fall Asleep

Butterfly positions are often referred to as "vacation positions." They're low cost and have minimum risk; you can establish your position and then forget about it for a while. For most retail investors, there is no need for monitoring or adjustments on a daily or even weekly basis.

Again, as stated above, once the position is within three weeks of expiration, the investor should start to measure the risk/reward of holding the position. As you approach the final four to six days of trading, even if the butterfly is looking on target, the risk/reward of holding out to achieve the maximum profit at expiration becomes a bad bet. A relatively small move of 1% to 2% in the final days could wipe out the profits accrued during the prior five weeks of patience.

While I don't like to present option positions as lottery tickets that produce maximum profit when landing "on the number," the current market conditions suggest there is nothing wrong with scattering a few butterflies and watching the market reveal itself. Maybe a few of those precious creatures will alight on your magic number.

Just invite me to any butterfly-financed barbeques. I like lamb on the chop.

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