[Q&A]: Let’s talk butterflies…

Thank you to everyone who responded to my request in the last issue. If you remember, I asked which strategies you’d like to learn more about. Overwhelmingly, the response I got was butterflies.

So for this issue, let’s go back and revisit one of my previous calls, to look at some trading examples.

That way we can talk all about butterflies, and answer some additional questions from the previous issue…

Remember my issue ‘Cloud Kings Arising’?  The one where we talked about one of my favorite setups in ADBE?

Well, while I was internet-free, ADBE broke through resistance at $265 and is on its way to new highs (don’t jinx it.) It’s a great example of a Phoenix play, as well as one I traded with butterflies and a long call. So, I can answer several questions at once.

Why was it a Phoenix play?

Well, ADBE is at the top of my list of Cloud Kings — a carefully curated list of my favorite cloud stocks. I focus on trading these when I think the market is going to move aggressively higher. These are volatile stocks, but when you catch them at the right time, trading the breakout to new highs can really show you where the market’s going. The ‘Phoenix Flyers’ tend to lead the market (both up, and down), so it’s good to pay attention to what they’re doing.

The ‘Phoenix Flyers’ are the stocks that really fly when the market flies. You can’t have a whole portfolio of them, because believe me… they fly but when they drop, it’s fast and sudden. You have to have the stomach for them.

Cloud Kings Phoenix Grid: ADBE 1 Hour Chart

Check out the Phoenix Finder Grid, down at the bottom. Do you see how the cloud stocks all turned red, but then, they started shifting back to green? The light green box is indicative of a very strong, bullish trend. ADBE is clearly the stand out. I used Phoenix to enter ADBE just as it was turning higher. You can also see that NOW, DATA, and CRM are gaining strength. Most of the cloud stocks remain strong here — telling me my bullish take on the market is holding up.

All About Butterflies

Let’s revisit one of the comments from our members on last week’s post. Here it is:

Danielle,

Great, informative, helpful articles you have here!

Since you asked, I’d like to know more about butterflies! It seems like you, John, Henry, and Bruce always know just where to place the shorts… How do you guys always seem to know right where the price is going to be on the chosen expiration? And what makes you select said expiration to start with? When is it best to break a wing or not? These are all things I ponder on! And now, of course, I want to know what/when/why you might stack a butterfly!

Thanks for all you do, keep up the great work!

Let me answer a couple of these, and show you some examples.

Example One: Here’s a small, ADBE call butterfly position I had. I bought the butterfly for $4.45, or $445. I held this for 10 days, and sold it for $9.83 — more than a double. Here’s a screenshot of the position below:

You can reference the screen shot above, and compare it with the strikes I selected. The short strike is near resistance, and the long strike was right at the money (at the time). This enabled me to get a good price for the butterfly. It’s great for small accounts, or, when you don’t want to risk a lot. This long, call butterfly was meant for a trade in ADBE up to $275, near expiration. This is the best way to benefit from an upwards move.

Example Two: Here’s a long, call butterfly in Boeing. This ticker didn’t have a squeeze, but, due to the news-related fall, I wanted to jump back on it, once it started trading higher. A good way to do this is with a butterfly. Why? Because it’s conservative, and it’ll allow you to hold through market movements. The first one I placed was a bit early, but this one came through well.

There’s a lot to this one, so I’ll save this for the next issue coming later this week.

Now that I gave you a few examples, let me get to your questions:

Q: How do you know where to put the short strike, and how to time it correctly?

A: This is an art, and it comes with experience. But, the basis is just technical analysis. The short strike needs to be around your target, and it needs to be timed so that the stock will hit that target, around that time frame. Sometimes I’ll place the expiration a little too early. In this instance, I usually add another one at a later dated expiration. But, primarily, what you’re doing is looking for your target, and resistance, to place the short strike.

Q: What type of support and resistance, as well as strategy, do you use for targets?

A: I like to use Fibonacci extensions, moving averages, and Voodoo lines. Then you have to take into account if the ticker’s squeezing or not and the expected move. Without a squeeze, I’ll time the fly with the expected move. With a squeeze, you have to move up your time frame. Why? Because the squeeze is telling you there is going to be a greater than expected move.

Q: What are stacked butterflies, and why do you use them?

A: I call them stacked flies when I’ll place multiple flies on the same ticker, with different expirations and different strikes. I do this because you can basically follow the stock upwards (or downwards) and create income each week, along the move. Instead of a long call, where I get in, and wait for the full target, with the stacked fly strategy, I can have a trade on each week, on the same ticker, and follow it higher as it explodes. This just gets you more mileage out of the move, and you aren’t sitting through ups and downs like you do when long calls go up then pullback.

I still have several more questions that I want to take the time to answer. So, I’ll answer some more next time!

4 thoughts on “[Q&A]: Let’s talk butterflies…”

  1. Thanks Danielle. I missed the last post so I’ll add my two cents here if that’s ok. I’d love to know more about credit spreads for income. Specifically, how to select the correct strikes and expiration?

    Reply
  2. Danielle,
    Great info on the B’flies. Do you also use unusual option activity as a pinning play for call butterflies?
    Is there a minimum time frame that you use such as one week to expiration or longer?

    Reply

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