Wednesday, June 24, 2009

A Butterfly Spreads Its Wings on Wall Street -

A keeper for showing Butterflies in class! My number one piece of advice on ANY derivatives trade? Draw the payoff and profit diagrams.

A Butterfly Spreads Its Wings on Wall Street -
"Here's how a typical butterfly or fly trade works.

Palsson told clients to consider buying an August 90 put and an August 70 put on the Standard & Poor's Depositary Receipts (SPY), an exchange-traded fund that tracks the S&P 500 index. At the same time, Palsson advised clients to sell two August 80 puts. SPY was at about $89 when he recommended the trade, and was recently at about the same price. The trade costs $1.85, representing the limit of the loss if the strategy fails.

The strategy is called a butterfly because when it is executed it looks like the often colorful insect. Effectively, traders are long the wings -- the August 70 and 90 puts, and short the body -- the two August 80 puts. (Read that sentence again because this can be confusing and complicated material.)"

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