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Phil
September 18th, 2014 at 9:49 amButterflies/DM – I don't remember ever doing a big, specific thing on them. Generally the criteria is stocks that pay well for front-month contracts but aren't actually that volatile over time. Take WMT, for example, it's pretty violent, month-to-month but, over two years – it goes nowhere:
So, with WMT at $76.50, we can buy the 2016 $65 puts for $1.85 and the 2016 $82.50 calls for $2.20 (since we think it's a bit more likely to go up than down) and those then act as stop-losses to short puts and calls we sell.
Those two contracts cost net $4.05 and we can then sell the Nov $77.50 calls for $1.10 and the $75 puts for 0.95 and now we've collected $2.05 in premium against our $4.05 entry (50%) using just 64 of the 483 days we have to sell (13%). So we have 8 sales like that to make and, if we collect $16 in premium vs our $4.05 entry – we have an excellent chance of making money.
If WMT is over $77.50, we owe the caller money but the short puts expire worthless and if WMT is under $75, we owe the short puts money but the calls expire worthless so we have $2.05 of leeway in either direction before we take a loss so our "safe" range for WMT is $72.95 to $79.55 – pretty much covering the channel's highs and lows.
If we have to roll, we roll to widen the spreads if possible but we also watch the range as a move up to $79 on so-so earnings (11/13) would probably lead us to bet the $80 line still won't break to the upside. On the whole, if all goes well, this is the dullest strategy in the World!