My step-by-step guide.
Yesterday I took the time to give some examples of recent butterfly trades, but I wanted to highlight Boeing more than what I got to discuss yesterday. So let’s take a minute to dive into Boeing.
As we all know, Boeing has been in the news on a daily basis due to the second plane crash the 737 Max experienced. Now, I don’t want to brush past the obvious sadness of this event. It’s terrible what’s happened, and Boeing’s role in it. But — as investors, we always have to look at what this does to the stock, and how we should react.
I began entering Boeing positions a few weeks ago. This week, Boeing rallied up to its 50 SMA at resistance, where I took my profits. Plus, trading news-related events is a part of the trading game… you can’t avoid them.
So let’s talk about how and why we should trade news-related falls…
News-related Reactions
Whether it’s an airplane crash, an automatic car crash (Tesla), a scandal with the companies CEO (WYNN…many others), or litigation (JNJ), traders need a formula for what to do when these events occur — whether you’re currently in a position, or if you want to enter one. Even if it’s only a formula for what ‘not to do’ when you’re long and the CEO of the company gets hit with criminal allegations overnight.
Here are my steps I follow when a stock gets hit due to news:
1. Look at what the stock was doing, previous to the bad news. Was it a Phoenix? This is the most important step. It’s only a buying opportunity IF the stock was previously strong.
- How can you tell? I like to look for a strong, trending pattern. I like to see price above the moving averages, and I like to see pullbacks hold the 34 EMA, and if not that level, than the 50 SMA. On a news-related hit, I like to see them hold the 200 SMA. Beyond this level, is when I question its ability to rise. I also like to compare the stock to others within its industry. Boeing, for example, doesn’t have many strong competitors. Sure, there is Airbus, but in reality… Boeing is much stronger in every way. You don’t want to buy news-related dips on a stock that was weak, prior to the announcement. (P.S. This is a good time where Phoenix comes in handy.)
2. Consider the news announcement. Is this a one-off report, or something that’ll probably continue in the news cycle? Remember, news comes and goes. Most stories are only in the news for a couple of days. However, in a situation like with Johnson and Johnson and the scandal involving asbestos and baby powder, this continues to be in the news as people continue to sue, and get judgements, against JNJ. That isn’t great for a ‘buy the dip’ situation. (If you want to know more about this, check out this article.)
3. Watch the price action. This applies if you’re already in a trade, or if you want to get in one. Usually, the first hit will be sudden, more than likely a gap down overnight. When you’re already in a trade, there isn’t much you can do here. In this instance, I generally won’t panic and sell. Why? Because I know it usually levels out. So, I watch for the level. If I’m not in a trade, and I want to get in one, then I wait until the leveling happens.
4. Price Levels Out… and Phoenix Starts to Rise. I go down to a lower time frame chart, usually a 15 or 30 minute chart. I watch for the low to hold, and then for price to slowly stair step higher. You can see this on the trend strength candles, as they switch from red to yellow, then green. The confirmation is the moving average cross, to the upside. This is my entry (or my signal, if I was already long, that it’s coming back).
Case Study: Boeing
This is the strategy that I used to get into Boeing. You all know I typically look for a squeeze. Well, this isn’t a squeeze trade. It’s a reversal, off of the lows. This is why I use a butterfly. I’m not looking for an explosion, I’m looking for a slow grind higher. The most conservative way to make money on this is by using a butterfly.
Why? Butterflies hold value well when your long strike is in the money, and they sit easily through ups and downs (that generally come with a news announcement). I aligned it with key technical targets, to get the most out of my fly.
Now, I was a bit early on my first entry, but that’s why I stacked my flies.
What does this mean? It means that I placed multiple flies with varying expiration dates. Here’s one that I took off on Monday. I paid $6.14 for this fly, and took it off at $10.56.
Check out this chart of Boeing:
The point here is that you can make money off of news-related events, and you can do it by recognizing if a stock was a Phoenix to begin with… and then, by getting in at the turn when Phoenix starts to show her wings.
Is there a rule of thumb for how far out to open a Butterfly trade?
And should one wait for expiration or a few days before?
Thank You for your insight and explanations
Hey Charles,
It depends on what setup you’re using to get into the trade. Generally, you can align it with the expected move listed in the options chain. If you’re trading a daily squeeze, usually 15-21 days is a good amount of time. If you’re trading a 30 minute squeeze, then yes you’d want to do it that week. It depends what time frame setup you’re using, and how long you think it’ll take you to get to your target.
Hope that helps –
Danielle
Thanks, Danielle, for your great explanation of Butterfly’s. As a new member and participant in John’ SAS class, I appreciate this conservative approach and will make use of this strategy.
Thanks, Dale! I’m glad you found it helpful. Butterflies are a really great way to mitigate risk and enable one to sit through movement. I also love the (generally) low cost.
-Danielle