SPDR 500 Trust (SPY) is up 73 cents to $140.08 on share volume that is running less than half the normal. 56.5 million SPY shares traded so far, which puts it on pace to be one of the lightest in recent memory (52-week low volume is 80.45 million set on July 3). Options volume is not quite as anemic, but still only 63 percent the expected levels. 404,000 calls and 723,000 puts traded on the Spiders so far. There have been just a few significant block trades in the product and the six largest are part of directional short-term put butterfly spreads. The Aug 130 – 134 – 138 put fly was bought this morning for 42 cents, 10000X on AMEX. Then, a bit later, the Sep 125 – 130 – 135 put fly was bought for 46 cents, 10000X. The spreads are probably designed as short-term hedges in the event SPY gives back some of its two-month 9.4 percent advance. SPY is today moving back within striking distance (1.3%) of the $141.84 per share 52-week high recorded on 4/2.
Let’s take a look at the Aug spread, which expires in 11 days, as a short-term case study. Since VIX is at the lower end of its recent range, the market might be a bit toppy and set the table for a move lower. Obviously, if the market moves higher instead the trade will be a loser. Nevertheless, we’ll open it as Case Study, as we already have a number of bullish positions open and the put fly can serve as a hedge if things get sour again over the next two weeks.
A put butterfly spread is a three-legged strategy which includes a body and two wings. The spread is typically initiated for a debit, and can be used when the you expect rangebound move in the underlying or if you want to target a directional mover lower. In the long put fly, the strategist is selling one strike for the body of the spread and buying (half as many) of a higher strike for one wing and also buying a lower strike for the other wing. The price target for the underlying is the middle strike or the body of the fly. The trade can be also be viewed as buying a put spread and selling a lower strike put spread. Deep out-of-the-money put butterfly spreads can often be initiated for small debits, but have a smaller probability of success compared to an at-the-money or near-the-money fly. Institutions often use put butterfly spreads on some of the exchange-traded funds to hedge stock portfolios.
In this case, shares are trading for140.05 and SPY Aug 130 – 134 – 148 put butterfly spread traded for 0.42. The risk to the trade is the debit paid, or 0.42 if shares hold above the higher strike or fall dramatically below the lower strike, which represents declines of 1.46 percent and 7.18 percent below current levels . The first breakeven is equal to the higher strike price minus the net debit, or 137.58 ad -1.77 percent from current levels. The second breakeven is equal to the lower strike price plus the net debit, or 130.42 and -6.88 percent from current levels. The max profits happen if shares fall to the middle strike, or 4.3 percent below current levels. The max potential profits equals the difference between the first two strikes minus the debit, or $3.58. The OptionsXpress payoff chart shows the risk-rewards and probabilities of success graphically.
Case Study – SPY Aug 130 – 134 – 148 put butterfly spread @ .42
Bias = Bearish
Risk = Debit=0.42
Reward = Diff in strikes – debit =3.58
Breakeven=lower strike + debit =130.42
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About the Author (Author Profile)
Frederic Ruffy is a well-known trader, writer, and strategist who has spent years educating investors and creating intelligent, insightful, unbiased market observations that are frequently cited by the Wall Street Journal and other financial publications. As senior analyst, Fred provides frequent and regular notes and daily updates for activity of interest.