Hey 5-Star Trader,
Elon Musk recently made big news in furthering his lead of being the wealthiest person on the planet. Though Musk is involved in a variety of different projects, certainly Tesla (TSLA) has been a huge attributing factor to his success.
Tesla has been a huge part of my life as well. After being introduced to this ticker, TSLA quickly became one of my top traded and most profitable stocks. Logically, the next step for me was to see what the fuss was about and I purchased a Tesla myself earlier this year! So, in celebration of Musk’s status, I want to share with you how I would set up a butterfly in TSLA during the “run into earnings” so hopefully Tesla can become a part of your life, too!
Step One: Charts
When prepping for a butterfly setup, the first thing I do is start with the chart and overall macro story. I did this just a few days ago during the TSLA “run into earnings” period. I saw that it had a nice consolidation on the weekly chart (a squeeze). When the squeeze “fired,” it experienced a volume breakout which overlapped with the ‘run into earnings” (which is when I usually trade it).
Step Two: Compare historical data
The current chart for TSLA looked good so I moved on to historical data. This step is very important because the historical data might give you clues to help anticipate the move after the report. Running TSLA through my Hot Zone tool* I saw that, historically, on average it trades higher by about $200 in the 21 bar period pre-earnings.
*I like to use my Hot Zone tool which adds overlays and time frames that give a trader a visual for past earnings reports, but you can do this process manually.
Step Three: Find a target
Once I have examined the past and current charts I start to look for a center strike (a target). To do this, I enlist the help of Fibonacci lines. In the case of TSLA, $1,000 was my first target, but we already met that. My next target would be $1,200.
To make accurate butterflies, you absolutely have to have a reasonable target. Then, it’s about the outside strikes.
Step Four: Set remaining strikes
In order to complete the butterfly, the next step is to set the outside strikes. I find this step the most difficult for people because they like to set their butterfly strikes too close together. The closer you set your strikes together, the more likely they won’t work. I like to use my center strike as a guide and overlay the expected move (found in step two) and then set the outer strikes as wide as I can afford. This way it has a bigger shot of having real value.
In this specific case, a ticker like TSLA has also been known to easily beat what the market makers are pricing in for the anticipated move, so I would adjust my strikes accordingly. An example of completed strikes (if I decided my target was $1,050) would be 1020/1050/1075.
Setting butterflies is definitely an art and not a science, but there are actionable rules I live by to help guide me into a probable strike pattern. Butterflies are one of my absolute favorite setups to use!