Tactical Options Trade on Johnson Controls: Firing LIne

Here are the details of a long -call butterfly trade on Johnson Controls.
By Matthew "Whiz" Buckley ,

With the market breathing a sigh of relief today from the agreement to extend the Bush tax cuts, let's turn our sights to a target with a moderately bullish strategic mindset,

Johnson Controls

(JCI) - Get Report

.

To see this trade discussed in a live trading brief with

CNBC

's "Fast Money" contributor Jared Levy on Thursday morning at 9 am, click

here

.

Strategic Mindset

Johnson Controls is the world's largest producer of conventional lead-acid car batteries, in addition to auto interiors and non-residential HVAC systems and energy efficient products.

At Fox3 Options we're moderately bullish, so we're taking a look at a potential trade with reduced risk and limited upside.

The reason for the tactic we're thinking of employing is we expect moderate upside, given the huge run-up the stock has seen. The next large number is $45 and we may also see a volatility crush after the January earnings report.

The stock is up in the air here, which is the reason for the reduced risk of the tactic we've selected.

Target:

JCI Trading at $39.65

Commit Criteria

This trade is supported by three fundamental theses. The first is the race to build the best electric car battery; the second is the economic recovery and increasing automotive sales; and the final is the continuing green movement in construction.

These are all longer term expected trends, which is why April was chosen.

Tactic: Long Call Butterfly

The tactic that we're using for this trade is a long call butterfly. Long call butterflies will always cost you a debit. This strategy prefers minimal movement around the center strike or gravitation to the center strike, which is our sentiment here.

We would prefer the stock to move right to $45 by April expiration or slowly up to it sooner. We also want volatility to decrease if JCI is close to the $45 price. If JCI begins to move outside of our breakeven points, we will exit the trade.

Tactical Employment

  • Buy to open 5 April 40 calls
  • Sell to open 10 April 45 calls
  • Buy to open 5 April 50 call
  • As a spread
  • For a net debit of $1.05 (max limit)
  • Max risk per spread = $1.05 ($105) per spread
  • Max profit = 3.95 per share; $395 per spread
  • Break evens = $41.05 to 48.95 (we profit in between those levels) max will be at 45
  • If we don't get filled at $1.05, we can move order to $1.10 bid

Here's how the tactic is employed: We'll buy the call butterfly spread by buying the April 40 call and 50 call 5 times, simultaneously we will be selling 10 of the April 45 calls as a spread for a net debit of $1.05 or less.

If the stock stays around $45, then the spread will increase in value from theta and possibly volatility. Our mission objective is to have JCI right around $45 on or before April expiration.

Mid-Course Guidance

We will monitor the trade for changes in price and this trade is nice because it shouldn't decrease in value quickly unless the stock makes a huge move, at which point we will evaluate. It is also very low in cost, about half of what it would cost for the 40/45 call spread.

An acceptable target is if we can sell the butterfly for $2.25 before earnings that is. Time decay will help us, but most likely will be countered by the increase we could see in implied volatility up until the report will prevent big gains until after the report is out.

Eject Criteria

The loss maxium would be $1.05, which would mean risking 100%. So if the spread decreases in value by what we paid, the trade is over. This is a speculation trade, where we are using 100% of the premium as our stop loss. If we wanted to lessen our risk, we could simply buy less contracts.

Long call butterflies like this one should not have volatile draw downs in value as long as the stock stays within range, but will also be limited in upside. We will most likely not be able to get the max profit of 3.95 cents until closer to expiration and chances are we will never get to see the entire $3.95.

We will keep the trade on and have our wish order of $2.25 to sell the spread out there every day until the earnings report.

Profit Goal

Preferably, we would like to get $1.20 return (115%) out of this trade, which could occur before earnings, but most likely would happen after. We won't be Gordon Gekko on this trade and be overly greedy, although there's nothing wrong with that. If you have this profit, we'll take it! We simply sell the fly back to the market for $2.25, which will be a return of 115%. Not a bad day at work.

We have a reduced risk/reward ratio, because we are risking only $1.05 to make $3.95 potentially.

Exit

  • Sell to close 5 April 40 calls
  • Buy to close 10 April 45 calls
  • Sell to close 5 April 40 calls
  • As a spread
  • For a net credit of $2.25 or more

Firing Line: To discuss this trade with CNBC Fast Money trader Jared Levy on Thursday at 9 a.m., click

here

. With limited risk and upside, we think this trade could be a good way to ring in the New Year and let us buy a couple GI Joe's with the King Fun grip.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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