Thursday, June 10, 2010

Rolling on the Fly

Due to GLD's recent failure to breakout to new highs, I rolled the call spread outlined in Evolution of a Bullish Risk Rocket to a butterfly. Those familiar with the original post are aware that we were already in a risk free June 121-124 bull call spread. In fact, our minimum reward came out to $132. Given the already advantageous position we were in, why bother with further adjusting into a butterfly? Though I could cite several added benefits, let's focus on two.

1. A Higher Minimum Reward: In order to roll the long call spread to a fly, we added a short call spread. The credit received from selling this spread directly increases our minimum reward.
2. Profit Zone Shifts: The fly's risk graph provides superior profits at GLD's current price versus the original call spread. This downward shift of the graph puts me in a better position if GLD fails to rise above 124 by June expiration.

Consider the original call spread's risk graph:
[Source: MachTrader]
Consider the new butterfly's graph:


The only outcome that will result in the fly under performing the original call spread will be if GLD rises past $125 by next Friday (June expiration). While anything is possible, it's fair to say a surge of that magnitude with only a week remaining is highly unlikely.

For related posts, readers can check out:
Adjustment Thinking and the Salvation Syndrome
Decision Trees
The Sling Shot