Best of the Week
Most Popular
1.Trump Delirium Triggers Stock Market Brexit Upwards Crash Towards Dow 20,000! - Nadeem_Walayat
2.The Future Price Of Gold Will Drop Below $1000 In 2017 -InvestingHaven
3.May Never Get Another Opportunity to Buy Gold at this Level Again - Chris_Vermeulen
4.Delirium - The Real Reason Why Donald Trump Won the US Presidential Election - Nadeem_Walayat
5.Why Nate Silver / Fivethirtyeight is one of the Most Reliable Election Forecasting Indicator? - Nadeem_Walayat
6.Gold Price Forecast: Nasty Naughty November Gold Price Trend - I_M_Vronsky
7.Gold Mining Stocks Screaming Buy! Q3’16 Fundamentals - Zeal_LLC
8.Delirium of Trump Mania Win's Mr BrExit US Presidential Election 2016 - Nadeem_Walayat
9.The War On Cash Goes Nuclear In India, Australia and Across The World - Jeff_Berwick
10.Hidden Signs for Gold and Silver - P_Radomski_CFA
Last 7 days
Crude Oil and Gold, Silver Precious Metals Link - 8th Dec 16
Stock Market and the Great Middle Class Revolt Gets Bigger - 8th Dec 16
Protectionist Trump Policies To Crash Dollar, Gold and Bitcoin to Soar - 8th Dec 16
The Jaws of Life : The Most Hated Stocks Bull Market in History! - 8th Dec 16
Infrastructure A Budding Asset Class - 8th Dec 16
Trump Stocks Bull Market Furious Rally Towards Dow 20k as Bear Mantra Persists - 8th Dec 16
More Talk About More Economic Growth and More Globalization - 7th Dec 16
Cracks In US Treasury Bond Market, The Japanese Factor - 7th Dec 16
The Rise of Anti-Establishment Italy - 7th Dec 16
Trump Likely to Drive Another Bump in Stock Market Buybacks — Here’s How to Hedge - 7th Dec 16
World War II and the Origins of American Unease - 7th Dec 16
Online CFD Trading for Traders on a Budget - 7th Dec 16
Silver Bullion Price Buying Opportunity for 2017? - 7th Dec 16
The Imminent Multi-Trillion Dollar Surge In Social Security & Medicare Costs - 7th Dec 16
Gold Bullion Price Buying Opportunity for 2017? - 6th Dec 16
Shariah Gold Standard Approved for $2 Trillion Islamic Finance Market - 6th Dec 16
THE Gold Play for 2017 - 6th Dec 16
Trump Sets The Stage For A Huge Gold Rally In 2017 - 6th Dec 16
BrExit Tsunami Claims Emperor Renzi's Scalp, Counting Down to End of the EU, Next? - 6th Dec 16
Failed EU - Means an Expanded Dictatorship - 6th Dec 16
Crude Oil Prices: "Random"? Hardly - 5th Dec 16
The Coming Stock Market Crash and WWIII - 5th Dec 16
This Past Week in Gold Market - 5th Dec 16
Stock Market Short-Term Correction Underway - 5th Dec 16
If Trump Doesn’t Do This, We Will Have the Great Depression 2.0 - 5th Dec 16
India’s Demonetization Could Be the First Cash Domino to Fall - 5th Dec 16
Our Future Economy, Jobs, Banking, And Governance - 5th Dec 16
Gold and Silver Bullion Buying Opportunity for 2017? - 4th Dec 16
First UK BrExit then Trump, Next BrExit Tsunami Wave to Hit Italy HARD Sunday! - 3rd Dec 16
The 10YR Yield and SPX Stocks Bull Markets - 3rd Dec 16
Gold And Silver – Do Not Expect Much Difference With Trump Compared To Obama - 3rd Dec 16
Gold, Currencies and Markets Critical 61.8% Retracements - 2nd Dec 16
Gold Junior Stocks Q3’16 Fundamentals - 2nd Dec 16
Adventures in Castro’s Cuba - 2nd Dec 16
We Are Putting Off the Inevitable - 2nd Dec 16
Macroeconomic Cycles & Demographics - A Fuse, An Explosive and The Igniting Catalyst - 2nd Dec 16
How Moving Averages Can Identify a Trade - 1st Dec 16
Silver Prices and Interest Rates - 1st Dec 16
America, is it Finally time for us to say Goodbye? - 1st Dec 16
Blockchain Technology – What Is It and How Will It Change Your Life? - 1st Dec 16
Burn the Flags, Can Trump Salvage The Sinking US Economic Ship? - 1st Dec 16
Will US Housing Real Estate Market Tank in 2017? - 1st Dec 16

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

$10000 Gold

Using a Put Butterfly to Options Trade Cummins Inc.

Companies / Options & Warrants Dec 22, 2012 - 03:17 AM GMT

By: J_W_Jones

Companies Entomologists tell us that a group of butterflies can, at the choice of the writer, be termed a lek, a rabble, or a swarm. I was first struck today by the bearish Fibonacci based pattern initially described by Larry Pesavento termed a bearish butterfly which had completed in heavy engine manufacturer Cummins Incorporated (symbol CMI).  


As improbable as it might be, I was pleased to find that a high probability option structure that could be used to trade it, the put butterfly. I thought it would be interesting to examine for educational value this rabble.

First, let’s look at the chart pattern. The price pattern termed a butterfly is a high probability reversal pattern that can occur in both bullish and bearish configurations. It is a variant of a two step pattern and also a variant of a more commonly known Fibonacci pattern, the Gartley.

The essential elements of the pattern are an initial impulsive thrust (classically termed the X:A leg), a reversal of 0.618 to 1.00 of the initial thrust (the A:B leg), a second thrust in the direction of the initial leg (the B:C leg), and the final reversal thrust opposite in direction from the initial X:A leg extending from 1.272 to 1.618 of the initial leg. 

Verbal descriptions are confusing, but consider the characteristic visual pattern which is easily recognized once the trader is familiar with the pattern.

The pattern completed last Friday as indicated on the graph, and today’s bearish candle constitutes a trigger for the trade. These patterns have approximately a 67% probability of success.

The option position I chose to trade this pattern is that of a classic put butterfly. For those not familiar with this structure it is a three legged structure that is composed of long positions for the wings and a short position for the body. 

The classic butterfly is always constructed in the ratio 2/+1 and the long positions are equi-distant from the short position comprising the body. The position is a debit position meaning that money is deducted from the buying power of the account.

An option butterfly can be constructed using either puts or calls. It is important to understand that the maximum profitability of these trade structures occurs when price is at the strike of the body at expiration.  Therefore, if an individual butterfly is constructed to express a directional bias, it can be constructed using either puts or calls since the strike price of the body determines maximum profitability.

As an aside, variations of a classic butterfly do exist. Two commonly encountered variants are an iron butterfly and a broken wing butterfly.  The iron butterfly is a credit trade and is constructed using both puts and calls. 

The broken wing butterfly is built by buying the long options at different distances from the central body. We will discuss these less common positions as different trading opportunities are presented to us.

To return to our current situation in CMI, I chose a put butterfly using the 90/100/110 strike prices in the January series. I chose January because December expiration is only a few days away, and butterflies work best when given a bit of duration. 

Had weekly options been available for this underlying, I likely would have chosen to use them in order to tailor the time frame a bit shorter to allow a faster response to changes in P&L.

The P&L graph of this put butterfly is presented below.

Pay particular attention to the intermediate time curves indicated by the two broken lines in relation to the expiration curve indicated by the solid blue line. The broken lines represent the P&L today (the lower broken line) and halfway to expiration (the higher broken line). Note that the butterfly only reaches its maximum profitability at expiration.

Another characteristic is the difference in slope of the intermediate and expiration lines. While the intermediate time frames react gently to changes in price, the pace of reaction to price change increases dramatically as expiration approaches.

It is for this reason that many option traders routinely close their butterfly positions ahead of expiration. Most experienced butterfly traders do not allow their positions to go to expiration because of the position risk with adverse price moves.

We welcome you to try our service to learn about more high probability trade set ups and option positions to extract potential profits while defining risk precisely.

If you are looking for a simple one trade per week trading style then be sure to join www.OptionsTradingSignals.com today with our 14 Day Trial.

 J.W. Jones is an independent options trader using multiple forms of analysis to guide his option trading strategies. Jones has an extensive background in portfolio analysis and analytics as well as risk analysis. J.W. strives to reach traders that are missing opportunities trading options and commits to writing content which is not only educational, but entertaining as well. Regular readers will develop the knowledge and skills to trade options competently over time. Jones focuses on writing spreads in situations where risk is clearly defined and high potential returns can be realized. 

This article is intended solely for information purposes. The opinions are those of the author only. Please conduct further research and consult your financial advisor before making any investment/trading decision. No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.  


© 2005-2016 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife