Another (stupid?) Butterfly question

Discussion in 'Options' started by rickf, May 13, 2007.

  1. rickf


    (Disclaimer: I'm not looking for 'investment advice' but insights on an 'investing technique' instead.)

    So here we are at expiration week for May.

    The share price of one of the companies I track (DE) closed right at $120 on Friday.

    Given the $120 close, the P&L graph for a potential 115/120/125 Butterfly Spread for May shows a healthy profit 4 days to expiration because the underlying's last price is right at the short strike price of the spread. (Obviously it's not the full ROI because there's still time left 'till expiration.)

    I think that's the ideal position for building a Butterfly spread, yes?

    They're doing earnings on Thursday, and whle I would never do a Butterfly on a position as they announce earnings, I'm thinking that even if I held the spread overnight, and provided the underlying didn't move beyond the BEPs, this spread will be profitable, so this might be a well-timed spread in terms of where the short strike is versus the time remaining to expiration.

    Any thoughts? Thx.....
  2. If a stock reports earnings the last week of expiry, more times than not the atm straddle will not decay at all until after report. According to Earningswhisper, they report Wednesday before the open, so not sure when they report.

    Good luck.
  3. rickf


    Yep, I meant Wednesday. Been a long weekend. :(

    As long as the decay isn't that much, and the underlying stays somewhat-constant, I'm thinking this is a decent opportunity t get in and out of before earnings.
  4. How do you expect to make money buying this fly on Monday and selling it out on Tuesday before earnings? You will not make money doing this. Hold it through expiration or don't do it at all.
  5. I mean hold it through earnings or don't do it at all.
  6. rickf


    I guess I'm just trying to corroborate with wht my P&L chart shows.

    Held thru expiration, if the underlying stays at 120, you win maximum profit on the spread. If the underlying moves to (say) 118 or 122 at expiration, you win less -- but still end up in the green inside your BEPs. And if the underlying breaks out of the spread, you lose.

    Now, running P&L scenarios for the last few days just BEFORE expiration: my P&L graph shows the same proft potential at slightly-less amounts because the price of the underlying still is within the spread's BEP range.

    For example, if you establish the spread on Monday.....when looking at a P&L line for Tuesday, the P&L line for this spread still comes well within the profit "landing zone" of the spread, 3 days prior to expiration. Wednesday's P&L line has a little bit more profit, and so on until max ROI for the spread is reached at expiration. (All of which presumes, of course, that the underlying's price stays within the BEP of the spread).

    So my question is that if those charts are true, as long as the underlying's price still fits within your BEPs at tht earlier date you will earn on the spread -- sure, you would not make as much, but if you wanted to close the spread and take your lesser profit at that point, you could....right?

    That's my question tonight.

    And frankly, if I was going to hold a position at earnings, I wouldn't do a Butterfly -- too constraining for the chance of major movement, IMO.
  7. Maybe, maybe not.

    Usually, an at-the-money fly will increase in value approaching expiration. But, as the pimp said, the ATM straddle is unlikely to decay until after the earnings report. The smooth curve of your potential p&l chart does not apply in a situation with a big impact event before expiration.

    It's also possible (if not likely) that the ATM straddle will be so juiced the night before earnings that when you attempt to get out of your fly you will find you have lost money, even with an unchanged stock price. That, coupled with outrageous retail commissions and a bid-ask spread of at least $.20 makes it virtually impossible to make money buying this fly monday morning and selling it Tuesday afternoon.

    Legging into the fly and holding through earnings may or may not be a good play based on what you think about the report, but trying to buy this fly to capture a few days theta is definitely not a good idea.
  8. rickf


    Good insights, all --- mucho thanks!

    I slowly came around to that conclusion...that it might not be a wise idea... after doing a bit more homework and experimentation.

    Normally I stick with basic BCS or BPS for simple directional plays, but was dabbling with some of the more 'exotic' spreads, so to speak.

    Got to love paper-trading, that's for sure.