Lesson Overview

AMZN Risk-Free Butterfly

As stocks fell today we had a great opportunity to both exit profitable trades AND enter some really cool adjustments. In this multi-trade case study video we'll highly towards the end our AMZN trade we adjusted into a risk-free butterfly spread with no potential for loss. The original AMZN position was a call broken-wing butterfly spread but we reduced risk and banked a profit by purchasing back the embedded call spread for a debit less than the original credit we took in on the opening trade.

Show Video Transcript +

Welcome back, and in today's video, we're going to cover all of our openings, closing or adjusting trades for Tuesday, July 8. And we have a pretty busy day with orders; we had about 8 orders that we placed into.

I'm sorry, 6 orders that we placed into the market and had a ton of working orders of things that we'd like to get into so very, very busy and active day with implied volatility starting to jump a little bit as we get into earnings and obviously the stocks are selling off.

Now remember, as we go through this video if you guys have any questions or comments, please don't by shy to add them right below, I'll get back to each and every one of them personally.

I want to make sure that we make sure that this video is helpful to you guys as far as understanding why and how we make all of the trades that we do. So, let's start off tonight with a look at some of the opening trades. First, we have two credit call spreads that we entered today.

Now the reason that we entered call spreads is for LinkedIn, one because we're just a little bit bears on the stock, it sold off pretty big today. And as it sold off, implied volatility jumped.

And we also need a little bit of some negative delta. We've been taking off a lot of positions that are profitable. And now we need to start adding some of that more balanced negative delta to our portfolio.

We're getting a little bit too long right now. And I don't necessarily want to be too long as the market continues to move lower.

So the first one that we want to go over is LinkedIn which is LNKD. We went ahead and sold the August so that you can see the August 2014 monthly contracts, the 175, 180 call spread above the market.

So we sold the 175 and then we went back and bought the 180 call against it to help finance that sale. At the end of the day, the net credit that we took in is a credit of a dollar ten on the whole transaction.

So that moves our break even point up to around 176 or so and gives us a little bit of room between where the stock is now and where it could move in the future.

So here's a look at where LinkedIn is, obviously the most important thing here right now is that implied volatility is above that 50th percentile.

And we just started to see it today. Right, I mean look how big of a move that we had down in LinkedIn today, really just kind of shows you that maybe the market might start heading lower, so that's why we did the call spread above the market at around 176.

That puts our line in the sand up here, so it gives us a little bit of room for LinkedIn to rally back up after this quick little selloff which it might do.

Right? I mean, it's been known to have just a quick little sell off and then maybe rally back up a little bit, but we obviously want the stock to continue moving lower, and if it does, then we actually might turn this into an iron condor, a very wide iron condor, if implied volatility still continues to stay high.

As far as the actual strikes, so let's go here to LinkedIn. And you'll see we've already made about 20 bucks on this position today so, actually just very small movement and action on the underlying stock.

So, here's our position in LinkedIn on the trade tab, and you can see our strikes over here in the right-hand corner of your screen.

And the first strike, which is our 75 strike, actually has about a 76 percent chance of expiring out of the money. So, we're trading here with about 25 percent risk, meaning there's a 25 percent chance that we get hit and LinkedIn trades and closes above the 175 strike.

So we don't know what's going to happen all the way through August expiration, we have earnings coming which will be a big factor as well in moving the stock.

But right now we're turning with about 70 percent, 76 percent chance of success on this trade. Not too bad, I like our odds with LinkedIn right now.

All right, so the next one that we got into is a vertical spread in VXX. Now VXX is a put, I'm sorry, a volatility ETF and it's a little bit different.

And the reason that we got into it on the call side is not that of our typical kind of rules and requirements for call spread; meaning volatility above the 50th percentile.

That really kind of goes out the window when you start trading Vix and volatility products because they are volatility themselves. You can't measure volatility against itself, right?

So in this case, with VXX we have a small pot today in the Vix, and what we want to do is just get some exposure to the fact that if volatility continues to stay low generally, not today but just generally like it has and the market kind of finds a settling ground here of moving higher or sideways.

Then we could make some money by VXX continuing to move lower. Which it does. It has a future that makes it move continuously lower as volatility just sits here.

So what we did is sold the 29, 30 call spread, took in a credit of about 28 cents, still meets our requirement to take in about one-third the width of the strike as far as actual premium.

So we took in a little less than that, at 28 cents, we were looking for about 30 cents. That puts our break-even price around 29, 30.

I'm going to go to the chart of VXX. You'll notice that although it does mirror the Vix, that it has continued to move lower even though the Vix is moving sideways.

And we had that small pop in that thing today. And what we're saying is, You know what this thing may continue to move lower and have some nice shooting star pattern, so we're going to place our bet right above market here and just again, bet that the market continues lower.

The reason we did the call side and not just buy a debit put spread is because if we bought a debit put spread, we'd have to sell it to get out of it. And in this case, the pricing wasn't that great.

So we went ahead and sold the call spread. And if we're right we'll just let this thing expire completely worthless, saves a little bit of commission and just the hassle of getting back out of the spread.

So definitely a little bit more complicated trade. A little bit more advanced, just because of the features of the VXX. It's a short-term Vix ETF, so it's got a little bit of a feature that continuously makes it go lower, so we obviously want volatility at least at this point with this trade to stay low.

If it does go higher, we've got a lot of different opportunities that we can go after. All right so let's talk about some of the closing trades. The closing trades today were just taking advantage of the move down in the market.

As we get closer to July expiration, which is now 9 days away, we want to start taking off trades that are either profitable or scratch trades, where we're kind of making a little bit or losing a little bit.

IWM, I consider being more or less a scratch trade. We had traded IWM calendar the August/July 115 puts, so both 115 puts, one was for July, and the long was for August.

And IWM traded much, much lower throughout the day and in fact, these last two days have been great for this position. And turned it around from a loser into a small win.

So we wanted to take that opportunity to get this trade out of the portfolio before July expiration, sold this calendar back to the market for a 121 credit. Just made a small profit of 25 cents on it.

Again, the whole idea here is that we had this finding in our portfolio as a little mini hedge in case the market did go lower.

So, as it did go lower throughout the day and it kind of went into the 15 territories we were able to close it out before the rally at the end of the day.

So, really good nimbleness in being able to close this out. Just dumb luck as far as I'm concerned, the market could have continued lower, and we would have had a bigger profit or whatever the case is.

But to be able to close out at a pretty good point today and take a small profit on the trade when it's pretty much been a loser the entire month.

So, it just goes to show you that you just want to keep holding these positions as long as you can and let that duration type or that duration factor in the trade continue to work out.

All right, so the other trade that we closed out today is CVX. CVX was a nice little trade. It was a July 135, 125 debits put spread that we originally entered.

So we bought the spread and sold it back to the market today for about a 510 credit. And took in a nice, 54 dollar profit on this one after all the commissions and all that other stuff.

So really, really nice trade, CVX continued to move lower which is what we wanted to see. And again, with this trade, it was more of a directional trade in that we just wanted to see a move down in the stock.

And we got that move down in the stock. And we got a pretty nice move down in the stock, I don't know if we picked the exact top, but we're very close to it.

But after this long run up and go back to that video tutorial, right here at Option Alpha dot com, in the play list for members. You can go back to the video tutorial of this, and you can see that we just had this huge run-up and just made a bet that said, hey you know what?

After this run up the stock typically tends to either a) trade sideways or trade a little bit lower. And so that's what we did, and the stock did what we wanted to do.

Implied volatility remains low, so that didn't help us in this more of a directional movement of stock. But it gave us a real good opportunity to take some profit off the table again before expiration.

All right, so now let's get into some of the adjusting trades today. And the first one I want to go over is Chipotle. So, Chipotle is that broken wing butterfly that we had, it was a put butterfly that we had.

I'm sorry, a call butterfly that we had on Chipotle where we wanted the stock to trade lower than around 575. And obviously, the stock hasn't done that the entire month.

But, today and yesterday it's starting to make some pretty dramatic moves lower as we get towards expiration. So again, just reaffirming that you need to hold these positions as long as possible until they start to show a profit, right?

And keep your trade size small, and you're able to hold these positions long and kind of through a max loss situation, a paper max loss situation until you get to this point where you can either make an adjustment or even close out the trade at a profit.

So, with Chipotle let's go over the actual trade that we did and then we'll go into some of their particulars of the actual position. In this case, with Chipotle what we did is bought back the embedded vertical, I'm sorry not with Chipotle that was Amazon, sorry.

So with Chipotle what we did is sold a credit put spread below the market because the stock is much higher than our original position. So, even though we traded on the call side with our original butterfly what we did is went in and sold a very wide, a credit put spread, the 575 55 put spread for a 195 credit.

Now the whole idea here is that we are selling that spread to move up our credit and therefor take in a lower loss and still leave the possibility to make a profit on this trade.

Now it looks a little bit different once we actually look at the analyze tab but first, let's go over the actual stock movement, and you can see even though it kind of rally here at the end of the day, which is fine, that's absolutely fine with our position, that kind of even works in our favor, that's fine.

But you can see that it's been pretty much this rallying and stalled for the better part of this expiration cycle until these last two days.

So, anything can happen here in these last couple days. A stock can obviously move much lower, much higher, whatever the case is and it's got earnings right after expiration, so it's going to be a little bit of a bumpy ride for Chipotle.

But we still like the position and obviously made that adjustment today. To reduce our loss and still keep an opportunity for a profit.

So, what I want to do is go in here, and I'm just going to delete all these simulated trades. And this is our resulting position for Chipotle, what the profit and loss diagram looks like.

But before I do that, I want to show you guys what it looked like before we made this adjustment. So here's our broken wing butterfly in Chipotle.

Right, it's very similar to what we have going on Amazon and what we have going in Pandora if you're following those trades as well. And as Chipotle moved higher, right, Chipotle is trading up here around 586 now.

I mean, that obviously moved outside of our range to 1) make a huge profit or just make a small profit with the credit that we took in on the broken wing.

Now, that means that obviously, our risk is to the topside of this trade. So, to mitigate that to some extent, what we did is went in and sold a put spread below the market right now, again to take in credit.

Still want to keep a little bit of opportunity to make some money, but if Chipotle does continue higher the whole idea of this adjustment is to take in more credit which reduces our max loss.

Right now, if everything were to stay the same when we go all the way through expiration, we'd lose about 485 dollars. By making this adjustment, this is what our new resulting position looks like.

After all the trades and we have this new put spread below the market, we've now reduced our loss from 485 to 290. So that's made a huge cut in our loss, and we're still not done yet.

Right? We can still adjust this if we want to and we leave an opportunity that if Chipotle does continue to move lower like we originally expected that we have a nice window of opportunity between say 550 and 570 or so to make some money. Right?

After that, then we don't want Chipotle to move lower, we kind of readjusted our position and now we have kind of an unbalance on a condor if you will, that's what it kind of looks like as far as a profit loss diagram.

But that's the adjustment that we made. Taking credit, still leave an opportunity to make some money on this trade, it's got ten days to go, and it's starting to move.

So, we'll see where it goes, if it does continue to move higher, we might just roll up this put spread as we've done before with previous trades and continue to take in more of that credit reducing the loss.

All right, so for Amazon. Now, this is the one that we did a buy back of the embedded call spread. So for Amazon, we had virtually the same set up as Chipotle's original position, where we did a broken wing butterfly.

Now as opposed to Chipotle, that rallied higher, Amazon has continued to move lower through July expiration. So by moving lower, it gave us an opportunity to go back in and buy this embedded call spread that was kind of out there, kind of invisible to most traders, right?

We had originally sold the 340, 345, 355 broken wing butterfly, skipping over that 350 strike which is right here. Well, now, by selling a vertical we entered that 350 strike and get rid of, for all intents and purposes, the 355 calls that we are long.

Now we did this for a debit of 25 cents, which is key here because of the original spread that we entered, I think was for a credit of around 60 cents or 65 cents. So by buying this back for 25 cents, we lock in a gain of around 40 dollars or so on this trade.

But the key being that we have a huge window of opportunity now being long just a regular butterfly at 340, 345, 350. You can see here that this Amazon butterfly is just a regular butterfly, it looks very, very similar to most of the profit/loss diagrams you're probably familiar with, with the butterfly.

No broken wing side and no potential to lose money on this trade now at all. So it becomes this, it's a lottery ticket that Amazon trades higher between now and expiration.

If it stays here that's fine; we keep our 40 dollars that we had locked in by buying back that embedded call spread. But we have a lottery ticket here that could pay off almost 750 dollars if Amazon does rally up to around 345 by expiration.

And as I was just mentioning to a guy on coaching tonight, is that I've hit a couple of these throughout the years. So even if I do this trade, and yes the 40 dollars is a small profit, it locks in a gain, and it gives me 100 percent upside potential with absolutely no risk.

And throughout the years, I've been able to hit on like four or five of these throughout the year. Right? So you just have to play that, play those odds and just know that at some point you actually might have a nice little profit here.

So, we're going to hold this, all the way until expiration. If Amazon continues to rally up higher, we could have a good opportunity on our hands to make a couple of hundred dollars after risking practically nothing in this trade.

Which would be a huge, huge upside gain for us heading into July expiration. So, as always, I hope you guys enjoy these video tutorials, they are obviously meant to be helpful. If you have any questions or comments, please add them right below this video.

Make sure that you remember, if you are not a member of Option Alpha and you're watching this video somewhere out there online, on Youtube or something, that you're getting these videos about 15 days after everybody else in our membership is.

So you're behind the 8 ball as far as real time updates and videos. But the good news is that you can test drive everything that we have free for 7 days by just going to Option Alpha dot com, clicking on the orange button right on the home page.

And again if you guys have any comments or questions about these trades or any of the trades that we made today, please add them right below. I'll get back to each and every one of them tonight or tomorrow before the open. And happy trading.

Join 209,817 Options Traders

Membership is always FREE & you can upgrade anytime to unlock software tools.