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Microcap & Penny Stocks : Tonto and Janice Teach Investing -- Ignore unavailable to you. Want to Upgrade?

To: zonkie who wrote (151)	3/28/1999 12:04:00 PM
From: LTK007	Read Replies (2) \| Respond to of 302

Sorry to spoil this,but here is a srious answer,zonkie:) This is part of a larger Options site provided by Equity Analytics, Ltd. The butterfly spread is a neutral options strategy position most often involving three different strike price calls. One call is bought at the lowest strike price. Two calls are sold at the middle strike price. And one call is bought at the highest strike price. Although, it can also be implemented using puts. The investor would use this options strategy if he feels that the underlying security is not too volatile and won't experience too much of a net rise or fall by expiration. Both risk and profit are limited. And commission costs are high. The maximum net amount of profit is realized if the stock price closes at expiration at the strike price of the written options. Using XYZ as an example, assume the following: An XYZ November 90 call is bought for 6-1/2; two XYZ November 100 calls are sold for 3-1/2 each; and one XYZ November 110 call is purchased for 2 points. Buy 1 November 90 call = ($650.00) Sell 2 November 100 calls = $700.00 Buy 1 November 110 call = ($200.00) Total Net Debit = ($150.00) Net collateral investment = distance between the strikes + net debit [The butterfly spread is essentially a combination of two options strategies. It is both a bull spread and a bear spread. Therefore, the collateral requirement is the total required for both the bull spread and the bear spread. Despite the fact that the investor only has a net debit here smaller than the total margin required, there will be a reduction in the additional buying ability in the margin account.] Maximum risk = net amount of the debit plus commission Maximum profit = distance between the strikes - net debit Downside break-even = lowest strike + net debit Upside break-even = highest strike - net debit In our butterfly spread options strategy example the maximum risk is $150 plus commissions, the maximum profit is $850, the downside break-even point is $97, the upside break-even point is $103. The optimal butterfly spread to set up is one where the net debit is small. However, I don't recommend using calls at parity because of the risk of assignment. A small debit limits the amount of overall risk. The other thing to look for is that the stock should be near or at the middle strike price (the calls which are sold). Another thing one should look for is to set the butterfly spread up with a volatile and expensive stock. These stocks have strike prices 10 and sometimes 20 points apart. This gives the spreader an advantage. The spreader is at a disadvantage with a less volatile and less expensive stock. It probably won't have as many strikes available. The follow up action involved for the butterfly spread options strategy is to first watch for early exercise of the middle options. This would happen if the middle strikes were trading near parity. If the middle calls are exercised, I recommend closing the overall spread. If it looks like the calls may be exercised I also recommend closing out the spread. Keep a close eye on the stock if it is about to go ex-dividend. It could move the middle strikes in-the-money. The second thing to look for is that if the butterfly spread is profitable, consider closing the position out. This is especially so if the middle options look like they might move away from the middle strike price level. If the stock looks like it's going to move up above the higher strike or down below the lower strike, one might consider closing the trade. Even though the risk is limited to amount of the net debit, if the butterfly spread was set up with a large debit, closing at break-even might be a viable alternative. The butterfly spread is the only options strategy I can think of where it is possible to leg out of the spread profitably and safely. Because the butterfly spread consists of a bull spread and a bear spread, one spread may reach its maximum profit. For example, if the price of XYZ were to drop to about 90 the investor would be in a loss situation with his butterfly spread. However, the bear spread portion of his butterfly spread would be at its maximum profit potential. If he bought back the short leg of the bear spread portion for about 1 point and sold the long 100 call for about 1/2, he would have a bull spread which cost 2 points. He increased his risk by 1/2 point from 1-1/2 to 2. Should the price of XYZ increase above 95 he would be able to realize most of the initial profit from the butterfly spread. Because four different options are involved in setting up the butterfly spread, it becomes a very expensive options strategy to set up. Four different commissions are involved. Generally, the butterfly spread is set up by traders who have very low commission costs. The commission costs with this options strategy are an important consideration to take into account prior to initiating the trade.