This is a sample entry from John Payne’s newsletter, This Week in Grain, published on Monday, April 28, 2014.
Looking for a way to sell some option premium in the soybeans without taking on a massive amount of short term margin risk? Check out the short butterfly call spread.
Description: A short call butterfly consists of two long calls at a middle strike and short one call each at a lower and upper strike. The upper and lower strikes (I call these the wings) must both be an equal amount from the middle strike (body), and all the options must have the same expiration date.
Example: Sell 1 November Soybean 1240 call for 70 cents – Buy 2 November soybean 1400 calls for 19.5 cents each or 39 combined – Sell 1 November Soybean 1560 call for 7-4.
- Total collection of 38.5 cents before cost
Summary: This strategy will be profitable if the underlying contract is outside the wings (1240 put or 1560 call) at expiration.
Max loss: The maximum loss would occur should the underlying be at the middle strike (1420) at expiration. In that case, the short call with the lower strike would be in-the-money and all the other options would expire worthless. The loss would be the difference between the lower and middle strike (the wing and the body), less the premium received for initiating the position (in this case 1.60-.38=1.22 or $6020 before costs)
Max Gain = .38 cents, as long as prices are below 1240 or above 15.60
Why put on this trade? I like this trade for production side hedging. Markets like soybeans can be incredibly difficult to time. If you are trying to get short without getting to aggressive, this may be a good play. I also like it when combining this spread with an out of the money put purchase. The market can trade higher for a substantial period of time before losses set in due to time value decreasing. Producers can use this lightly and hope they are wrong as if prices rally into the middle of the spread in the July/Aug timeframe, the spread has only lost a fraction of what the grain the hedge represents has made.
THEORETICAL RISK GRAPH- Know what to expect!
WARNING: I advise anyone who is a first timer in a position like this to get some help with getting proper expectations. It is very important that you know what you are doing when you put on a trade like this. There are a lot of moving parts, more than I can simply describe in an email.
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Risk Disclosure
WHEN INVESTING IN THE PURCHASING OF OPTIONS, YOU MAY LOSE ALL OF THE MONEY YOU INVESTED.
WHEN SELLING OPTIONS, YOU MAY LOSE MORE THAN THE FUNDS YOU INVESTED.
EXAMPLES OF HISTORIC PRICE MOVES OR EXTREME MARKET CONDITIONS ARE NOT MEANT TO IMPLY THAT SUCH MOVES OR CONDITIONS ARE COMMON OCCURRENCES OR ARE LIKELY TO OCCUR.
STRATEGIES USING COMBINATIONS OF POSITIONS, SUCH AS SPREAD AND STRADDLE POSITIONS MAY BE AS RISKY AS TAKING A SIMPLE LONG OR SHORT POSITION.
YOU SHOULD BE AWARE THAT IN THE EVENT YOU LIQUIDATED THE LONG SIDE OF A BULL CALL SPREAD AND STILL MAINTAINED THE SHORT OPTION POSITION, THEN YOUR RISK WOULD BE UNLIMITED.
FOR CUSTOMERS TRADING OPTIONS, THESE FUTURES AND/OR FOREX CHARTS ARE PRESENTED FOR INFORMATIONAL PURPOSES ONLY. THEY ARE INTENDED TO SHOW HOW INVESTING IN OPTIONS CAN DEPEND ON THE UNDERLYING FUTURES PRICES; SPECIFICALLY, WHETHER OR NOT AN OPTION PURCHASER IS BUYING AN IN-THE-MONEY, AT-THE-MONEY, OR OUT-OF-THE-MONEY OPTION. FURTHERMORE, THE PURCHASER WILL BE ABLE TO DETERMINE WHETHER OR NOT TO EXERCISE HIS RIGHT ON AN OPTION DEPENDING ON HOW THE OPTION’S STRIKE PRICE COMPARES TO THE UNDERLYING FUTURE’S PRICE. THE FUTURES CHARTS ARE NOT INTENDED TO IMPLY THAT OPTION PRICES MOVE IN TANDEM WITH FUTURES PRICES. IN FACT, OPTION PRICES MAY ONLY MOVE A FRACTION OF THE PRICE MOVE IN THE UNDERLYING FUTURES. IN SOME CASES, THE OPTION MAY NOT MOVE AT ALL OR EVEN MOVE IN THE OPPOSITE DIRECTION OF THE UNDERLYING FUTURES CONTRACT.
THIS MATERIAL IS CONVEYED AS A SOLICITATION FOR ENTERING INTO A DERIVATIVES TRANSACTION.
THIS MATERIAL HAS BEEN PREPARED BY A DANIELS TRADING BROKER WHO PROVIDES RESEARCH MARKET COMMENTARY AND TRADE RECOMMENDATIONS AS PART OF HIS OR HER SOLICITATION FOR ACCOUNTS AND SOLICITATION FOR TRADES; HOWEVER, DANIELS TRADING DOES NOT MAINTAIN A RESEARCH DEPARTMENT AS DEFINED IN CFTC RULE 1.71. DANIELS TRADING, ITS PRINCIPALS, BROKERS AND EMPLOYEES MAY TRADE IN DERIVATIVES FOR THEIR OWN ACCOUNTS OR FOR THE ACCOUNTS OF OTHERS. DUE TO VARIOUS FACTORS (SUCH AS RISK TOLERANCE, MARGIN REQUIREMENTS, TRADING OBJECTIVES, SHORT TERM VS. LONG TERM STRATEGIES, TECHNICAL VS. FUNDAMENTAL MARKET ANALYSIS, AND OTHER FACTORS) SUCH TRADING MAY RESULT IN THE INITIATION OR LIQUIDATION OF POSITIONS THAT ARE DIFFERENT FROM OR CONTRARY TO THE OPINIONS AND RECOMMENDATIONS CONTAINED THEREIN.
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE. THE RISK OF LOSS IN TRADING FUTURES CONTRACTS OR COMMODITY OPTIONS CAN BE SUBSTANTIAL, AND THEREFORE INVESTORS SHOULD UNDERSTAND THE RISKS INVOLVED IN TAKING LEVERAGED POSITIONS AND MUST ASSUME RESPONSIBILITY FOR THE RISKS ASSOCIATED WITH SUCH INVESTMENTS AND FOR THEIR RESULTS.
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YOU SHOULD CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR CIRCUMSTANCES AND FINANCIAL RESOURCES. YOU SHOULD READ THE "RISK DISCLOSURE" WEBPAGE ACCESSED AT WWW.DANIELSTRADING.COM AT THE BOTTOM OF THE HOMEPAGE. DANIELS TRADING IS NOT AFFILIATED WITH NOR DOES IT ENDORSE ANY TRADING SYSTEM, NEWSLETTER OR OTHER SIMILAR SERVICE. DANIELS TRADING DOES NOT GUARANTEE OR VERIFY ANY PERFORMANCE CLAIMS MADE BY SUCH SYSTEMS OR SERVICE.
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