Tuesday, May 3, 2011

Trade of the Day: TLT June $96/$98/$100 Call Butterfly

The Trade
A trader bought 10,000 June $96 calls at $0.74, sold 20,000 June $98 calls at $0.36, and bought 10,000 June $100 at $0.18 for a debit of $0.20 or $200,000.

As you can see from the graph above, the butterfly has limited risk and limited profit potential. The max risk is the debit. The max gain occurs at an underlying stock level of $98 at June expiration. The max profit at a $98 underlying stock level is $2,800,000. The profitable range for the spread is $96.20 and $99.80. TLT closed today at $94.17. Therefore, the trader is slightly bullish.

The lines shown are the lower and upper break even price levels. The spread is profitable if the underlying stock level is between the two lines. It's interesting to note that the current 200-day moving average is within the profitable range for the butterfly. TLT last traded in the profitable range on December 6th, 2010. The 52-week range is a low of $88.14 and a high of $109.34. TLT traded 89,761 contracts today compared to average daily volume of 34,369.

TLT is an index that measures the performance of public obligations of the United States Treasury that have a remaining maturity of 20 or more years.

Thoughts from the Flotilla Trade Desk: This is a classic "sell in May, go away" trade. If the market sells off, investors will sell stocks and buy bonds. This trade is a cheap bet that it happens.

No position at this time. Position declarations are believed to be accurate at time of writing but may change at any time and without notice.

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