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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