Friday, January 29, 2010

EEM Situation

This is a continuation of yesterday's post and explores 4 different butterfly scenarios using EEM puts to create a debit spread.
Scenarios 1 & 2 are based on a 2 strike spacing while 3 & 4 are based on 3 strike spacing. The thing I like about butterflies is that risk is capped (so is potential gain) and it's often best to exit these positions (or at least of portion of the position) once 50% of the target returns have been achieved. That decision, of course, is premised on the proximity of the current price relative to the maximum gain target and it's worth monitoring these positions intraday in order to capture potential profit pop surges.
The other thing I like about the butterfly is that you can skew the spread to neutral, bullish or bearish, depending on the target strike. Increasing strike spacing can produce a very wide opportunity window, while a narrower spacing decreases the net debit and typically increases the max risk/reward ratio . . in this case (scenario #1) 1.64/-.36 and opposed to scenario #3 . . 2.22/-.78. I'm currently inclined towards scenarios 1 & 3, especially after Thursdays drop back down to $ 38.41 . . close to the $38.65 price which produced a BUY signal on Wednesday.

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