Options Strategy: The Butterfly Trap Nets Huge Profits on Big Moves

As a professional trader I am NOT in the business of predicting the future.  Instead, I ANTICIPATE where a stock may go, and then apply the right strategy to profit from the move. I prefer to trade stocks like TSLA, AMZN, PCLN, and CMG … etc. because they have the potential to make big moves.

One way I trade these high-flying stocks is by setting up multiple butterfly spreads to essentially ‘trap’ their movements.  This is an intermediate/advanced concept so the best way is to illustrate this strategy with a case study.

Let’s look at the AMZN chart below:  the stock more than doubled in 2015, going from 300 to almost 700 by December 2015. At that time, if the stock was to have a correction, it should move down to the 1st support level at around 500, and then to 350 if the stock was really weak.  To the upside, the 1st equal distance target would be 800, and then 950 if the stock was really strong. 

I do this exercise to anticipate what the stock will possibly do over the next 12 months.  Once I have this “roadmap”, I am now ready to put on some butterfly spreads:

Source: TradeStation

Referring to the chart below, here are the butterfly spreads that I put on in January 2016:

  1. I placed an out-of-the-money put butterfly spread using April 2016 expiration with 500 being the short strike.  I was looking for AMZN to potentially drop to around 500 by April 2016 for this butterfly to be profitable.

  2. In case AMZN moves sideways or 650 ends up being a “sticky” area, I placed an at-the-money put butterfly spread using June 2016 expiration.  If AMZN hovers around 650 then this butterfly will be profitable.

    Source: TradeStation

  3. I placed a way out-of-the-money put butterfly using August 2016 expiration with 350 being the short strike.  If AMZN falls apart, this butterfly has the potential to make over 700%.  A great way to buy “insurance” for a stock in case it goes south.

  4. For a bullish scenario, I placed an out-of-the-money call butterfly using October 2016 expiration with 800 being the short strike.  In general, stocks move up 2 to 3 times slower than when they move up, so that’s why I chose a further out expiration date for this one.

  5. Should AMZN be very bullish and reaches my 2nd upside target of 950, of course I have a butterfly there waiting for it.  Similar to the way out-of-the-money put butterfly in (3), this butterfly also has the potential to make over 700%.  

So let’s fast forward to February 2017 to see what happened to these 5 butterfly spreads:

  1. AMZN dropped over 150 in January/February of 2016.  Although the stock was early reaching my target at 500 (remember I used April 2016 expiration), the stock movement alone gave this butterfly a +266% return.

  2. Then AMZN did a V-shape bounce and climbed back up to the 650 area by early May 2016, and the at-the-money 650 put butterfly gave me a +283% ROI.

    Source: TradeStation

  3. By August 2016 expiration, AMZN was very bullish and the 350 put butterfly expired worthless and I lost 100% of my money with that one.

  4. By September 2016 AMZN reached 800 and my October 2016 out-of-the-money call butterfly returned +487% profit.

  5. I have one more call butterfly at the 950 strike.  As I am writing this case study, AMZN is trading at about 860, so 950 is within striking distance.

A couple of key points about using this strategy.  First, always risk the same amount of money on each butterfly.  If I risk $10K on (1), then I must risk $10K on each of (2), (3), (4), and (5).  Second, always take profit when the stock hit the middle of the butterfly (or the short strike).  Remember, I am setting up these butterfly spreads as “traps”.  So when my prey (AMZN) falls into the trap, I must capture the available profit.  And because of the inherent high reward-to-risk ratio with butterfly spreads, even if I am right just 50% of the time, I still come out way ahead of the herd.

To further expand on this case study, I’ll be doing a few free webinars to show you one of my short-term butterfly strategies that consistently return 100-200% profit with 75% accuracy.  If this type of high reward-to-risk trading resonates with you, then I invite you to join me this week where I will show you the complete step-by-step execution of a consistently profitable options strategy.