Today, I want to dig into a unique trading strategy I recommend for my paid subscribers from time to time.
It's a move that allows you to lower your risk and cost - always something to shoot for - and still take those same massive profits we're always looking to grab.
It's called a "butterfly spread" trade, and it's perfect to use when the markets are experiencing high volatility like they are now.
Now, I can hear what you're thinking: "High volatility?! Tom, the S&P 500 is at record highs right now." But always remember, volatility is up and down movement; just because we're at record highs doesn't mean there's no volatility - we're just going through upside volatility.
Volatility of any kind can lead to an increase in option prices, which could make it tough to stick to one of my most important trading rules: I only enter trades that are $500 or less.
The butterfly spread works a lot like some other trades we've talked about before, but it has some unique benefits I want to tell you about...
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Pay Half the Price for High Potential Profits
My paid subscribers have had the chance to take down some massive gains with this trade. And when I say "massive," I'm talking 643% total gains on XLE... 384% total gains on TLT... and 109.76% on DIA...
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And that's just a few examples of the cash you can rake in with this trading strategy.
Now, after seeing that profit potential, it makes sense to be eager to just jump into the next trade that catches your eye.
But first, let's break down what the butterfly spread is and how the three-legged play serves up these massive gains...
A butterfly spread is a series of simple vertical spreads - buying to open and selling to close two options expiring on the same day at different strike prices - layered on top of each other - creating the "butterfly." (If you missed our quick guide to spreads and other safe trading strategies, go right here and get caught up.)
But with the butterfly, there's a directional "twist." Here's an example:
Say you want to add the iconic tech stock Apple Inc. (NASDAQ: AAPL) to your portfolio... but you don't want to wait two years for it to double on you. You know that for a fast and lucrative profit, options are the only choice.
You can buy a simple call for $5. That's not bad, but for control of 100 shares, that's $500, and you're looking for a cheaper approach.
You could do one of those spreads I just mentioned, which would run you around $2.50 - a much better price point. But with the power of the butterfly spread trade, you can get in on this global icon for $1.25 or less. This gives you even more room for profit - and it leaves more money in your pocket.
And that's why the butterfly spread is so powerful.
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Now, this trade is executed by buying two different options - one with a lower strike price (one of the butterfly's wings) and one with a higher strike price (the butterfly's other wing). Then, you sell the middle strike price (the butterfly's body).
Those are the "legs" of this trade.
This makes the butterfly a three-legged spread. All of the options in the spread will have the same expiration date, but each "leg" will have a different strike price. So, you will have a low-strike call, two middle-strike calls, and one higher call. But the catch is each leg will have the same expiration date.
- Lower Strike - This strike price will be below the current stock price.
- Middle Strike -This strike price will be as close as possible to where you think the stock will be at expiration.
- Higher Strike- This strike price should be the same distance from the middle strike as the lower is - just in the opposite direction.
Now, you will purchase (buy to open) the lower strike and the higher strike, while simultaneously selling (selling to close) the middle strike. The catch with the middle strike is that for every contract that you buy on the bottom and the top, you sell in the middle.
So, for instance, if you buy one contract at the high strike price and one contract at the low strike price, you'll want to sell two at the middle strike. And what this does is create an incredibly inexpensive trade setup.
This low price doesn't just set up an explosive profit though - it also creates a low-risk trade that gives you peace of mind but also allows you to cash in on the biggest profits.
To sum it up - the butterfly spread is designed to cost very little, all while creating the potential for high triple-digit returns when used on the right stocks.
Let's take a closer look...
How to Place a Butterfly Spread Trade
Now, I'm going to show you exactly how to place this trade by using a real butterfly spread Trade alert. I sent this to my Money Calendar Pro Members on Feb. 26, 2018.
(Remember, this is an old trade recommendation that's since been closed, so you do not want to actually place this trade. Plus, it wouldn't work even if you tried.)
Now, I usually send my paid subscribers detailed exit instructions so they know exactly when they've got a shot at our chosen profit target. But you can do this on your own, too.
When you've hit your profit target, you do the reverse of what you did when you opened the butterfly. If you bought to open, you'd sell to close, and if you sold to open, you'd buy to close.
This particular butterfly spread went from our fill price of $0.99 to $2. That's a 102% gain on just half of the position! And one month later, this butterfly spread had skyrocketed again, from our fill price of $0.99 to $3.39. That's 242.42% profits.
These are the types of gains you just can't get when buying the stock outright...
And that's where the real beauty of options lies. You can essentially "rent" an expensive stock for less while still capturing the same - or higher - profits that you would had you bought the stock outright. Think about this: One share of, say, Goldman Sachs Group Inc. (NYSE: GS) costs over $217 right now. To control 100 shares? That would run you north of $21,750! But when you use options, like my subscribers, you could have the opportunity to control the same amount of shares for less than $150.
When you look at it that way, no investor can afford to ignore options.
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About the Author
Tom Gentile, options trading specialist for Money Map Press, is widely known as America's No. 1 Pattern Trader thanks to his nearly 30 years of experience spotting lucrative patterns in options trading. Tom has taught over 300,000 traders his option trading secrets in a variety of settings, including seminars and workshops. He's also a bestselling author of eight books and training courses.