Monday, August 9, 2010

Flys... of the Butter Variety

Let's take a brief stroll down memory lane to last Thursday. With the jobs report coming across the wires on Friday morning, the day prior would have been an opportune time to take some money, and perhaps more importantly, risk off the table. Particularly on positions that had behaved well and accumulated notable profits. The OIH bullish risk rocket outlined in last week's Bulls Bid-up Black Gold post may have been one such position, so let's walk-through a strategic adjustment.

The initial trade involved purchasing 100 shares of OIH at $107.35 and two September 115 calls for $1.95 apiece. The underlying rationale for the play was to exploit further upside movement in the oil services space based on the breakout of an ascending triangle two months in the making. The original risk graph is displayed below:

[Source: MachTrader]

While the OIH didn't rise high enough to reach our initial target of $110.35, it had accumulated enough profits to merit an adjustment. As previously explained in Evolution of a Bullish Risk Rocket, common adjustments for the risk rocket include rolling to a call spread, butterfly, or condor. Given the fact that I believe the odds of OIH breaching $120 by September expiration are slim, I opted to roll into the 115-120-125 butterfly versus a simple 115-120 call spread. Since the butterfly involves selling twice as many 120 calls it brings in a higher net credit thereby locking in more gains versus the simpler 115-120 call spread.

To fully grasp the drastic risk differential between the initial risk rocket with the post adjustment butterfly, consider things from a delta perspective. Due to the aggressive nature of the risk rocket, its position delta was relatively high at +160. Morphing to the butterfly reduced the delta to a mere +10. Even if OIH were to have the bottom drop out of it, the rate at which the position gives back profits has changed from being akin to an open fire hydrant to more of a leaky faucet.

For related posts, readers can check out:
Adjustment Thinking and the Salvation Syndrome
Risk Rocket
Rolling on the Fly

1 comment:


One great topic on the markets moves.