Option Butterfly Spread: A friend emailed me the following. It was taken from an email commentary sent out by OptionsXpress.com
“The biggest options trade in the market so far Wednesday (1-12-11) is a block of 80,000 February 121 puts on the SPDR 500 Trust (SPY). The so-called “Spyders” is an exchange-traded fund that holds all of the S&P 500 stocks and is up $1.15 to $128.59. The big block of February 121 puts was part of an options strategy called a butterfly spread. In this position, the strategist sold 80,000 February 121 puts, bought 40,000 February 126 puts and bought 40,000 February 116 puts. They paid a net debit of 53 cents per fly. This butterfly is a directional play, as it makes its best profits if shares fall to $121 by the February expiration. An institutional option investor probably initiated the spread as a hedge.”
SPY closed today at 128.36
If you got into this trade at the close, the breakevens would be 116.55 and 125.40.
So this trade could be a bearish bet, or it could be a hedge. If it is a bearish bet it stands to make several hundred percent if SPY does indeed retreat close to 120 on Feb expiration.
If it is a bearish play, then for a pretty cheap price, (57 cents debit) the options trader can give himself nice way to protect his portfolio. If the market goes up, his main portfolio makes enough to offset the loss of this trade. If the market drops, the trader will lose on his main position, but make up most of it on the gain in the butterfly.
Notice that the trader used Feb expiration. So we can guess that this trader is worried about something happening before Feb expiration. My guess is earnings.
As you can see, adding a butterfly or other option strategy is a good, cheap way to insure your portfolio against losses.
Got questions? Please let us know in the comments section and please go check our previous blog posts for useful stock option trading strategies,