Butterflies for Earnings

How we trade earnings - cheap speculation

What is a Butterfly trade?

It is a combination of a debit spread and a credit spread put together.

Features of a butterfly:

• It is generally a debit trade.

• Low risk, limited profits

• Lower margin requirements with probability of higher ROI.

A call butterfly is: 1 long call closer to ITM, 2 short further OTM calls (same strike) and another long call way OTM. And a put butterfly is  1 long put closer to ITM, 2 short further OTM put (same strike) and another long put way OTM. Whether a call butterfly or put butterfly, the risk profile or pay off function looks same. The final payoff looks like a butterfly and as long the price on expiration is within the body of the butterfly, there is a profit. The underlying price movement is expected to remain confined into a limited range.

So, how do we at Monetive Wealth use this strategy to speculate on earnings without risking a lot. Earnings can he a hit or a miss. More than that the market reaction to any type of earnings can different from expectations. Also, a stock can have out sized moves too if positioning in the market place is lop sided. With so many unknowns, if there is a way to risk a little but the reward is good, then doing a earnings butterfly is an option. This is one trade strategy we at Monetive use during earnings season to express our opinion, take a small risk and hopefully make outsized returns.

4/19/22 after market is NFLX earnings. Based on the implied volatility, the market maker move for this Friday expiration is about $36. The move can be either up $36 or down $36.

So, if we think that a stock can gap down on earnings but still remain within the expected market maker move then we can do a put butterfly.

For eg: on NFLX: current stock price : 337

• Market maker move is $36

• March 2020 low is around 290

• Monthly POC (point of control) is 283.11 (these act as support)

  

One possibility for NFLX is to fade towards these support areas by Friday then a possible put butterfly trade would be

Buy 1 310 P, Sell 2 297.5P, Buy 1 285P for a debit of $1 per contract.

In this case, if NFLX pins at 297.5 strike price on this Friday then this trade can make a max profit of $11.5.

The butterfly width is 12.5 - $1 debit paid = max profit potential = $11.5

If NFLX gaps up, we lose $1. If $NFLX blows through 285 and closes Friday below 285 price then our debit spread is fully in the money and at max profit but our credit spread is at max loss. So, we would have to close the butterfly for a total loss. If we does not close the butterfly spread if all the legs are in the money then we will have go through assignment and exercise fees to get out the trade. So, it is easier and always better to close the butterfly trade before expiration.

At Monetive, we do quite a lot of butterfly trades for earnings if we are certain of the direction based on our assumptions of what the earnings might be.

This NFLX trade is just an example of how we do these types of trades.

Disclaimer: Finally a reminder that these are our opinions only and not a trade recommendation. Please always do your own due diligence and/or consult a registered investment advisor.