Casting a wide net with FAS butterflies

I have been mostly sitting on my hands for the past couple of weeks as the market levitates on low volume, but that does not mean you should not go fishing. Today I caught a nice butterfly spread on the triple leveraged financial ETF (FAS). A butterfly call spread is where you buy one call, sell two calls at a higher strike, and buy one more call at an even higher strike. The strikes are the same distance apart, and all of the expirations are the same. In general, I like butterfly spreads because they have a defined risk — you can’t lose more than you pay for the spread– they offer a nice amount of leverage, and they don’t suffer all that much from time decay (unlike, say, just buying puts or calls to get leverage and defined risk). On the downside, you have to buy four contracts for every spread, so the commissions can add up very quickly. Partly for that reason, I am partial to long dated butterflies. They can be a kind of “set it and forget it” investment — at least as far as options are ever are. In this case we are going way out to Jan 2012, so I hope that this position will be in the portfolio for a good long while, slowly rising in value each week. Here’s the trade:

Buy 20 FAS Jan ‘12 80 calls

Sell 40 FAS Jan ‘12 100 calls

Buy 20 FAS Jan ‘12 120 calls

Total cost: $1.10 per combo ($2,200)

What’s to like?

Nice leverage (20:1 max payout, if you get REALLY lucky — of course, here at Rick’soptionpicks we take gains long before expiration but if all goes well I would still expect a 300% payout.

Defined risk — we can only lose what we put up

Very slow time decay (low theta, and if FAS goes up a bit this will even turn positive for us)

What could go wrong?

FAS is crazy volatile, being a 3x leveraged ETF. If it quickly runs away from the strike zone ($80 – $120) the combo will get hurt.

Posted by rglenn8   @   11 November 2009

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