A "Win-Either-Way" Trade On China's New Stimulus Package

With data on the economy mixed – IPOs are down but private equity is ramping up; new housing starts are down but home sales are up; oil is down (during a hurricane cycle no less) but China is launching more stimulus to boost its economy – arguments can be made for bigger moves all around.

And I have a trade that will profit off these moves, whichever way they go.

Let me show you.

Today, we will use $BABA in a double butterfly formation – meaning we have the expectations of outsized moves but we are uncertain of which way. Indeed, it could be both. 

The premise is the following – we will buy a long call spread and sell a short call spread and the position will hold the same short strike; and we will also buy a long put spread and sell a short put spread and that position will also hold the same short strike.

We are anticipating a move out of congestion into either a breakout zone or prior support below. We are selling the short spreads so that we can making getting into the position more cost effective.

Trade structure – the double butterfly in $BABA

• Buy to open 1 BABA 15 Nov 105 calls
• Sell to open 1 BABA 15 Nov 110 calls
• Buy to open 1 BABA 15 Nov 115 calls
• Buy to open 1 BABA 15 Nov 85 puts
• Sell to open 1 BABA 15 Nov 80 puts
• Buy to open 1 BABA 15 Nov 75 puts

The debit and total at risk for the call side is currently priced at .18; the put side is currently priced at .39. So if both sides are taken, the total risk is 0.57.

To calculate the total possible profit (assuming the entire trade is covered when the mid strike is tested at expiration), we must do the following:

1. Measure the distance between the long call strikes – 110-105 = 5 x 100 (for each butterfly) = $500 minus the cost of the entire position = $500 – $57 = $443. This is the ideal (outside of commissions) and can only occur if we close the position at expiration at the middle strike.
2. The distance between the long put strikes is the same so we have the same profit factor if the chart falls into the lower edges.
3. The breakeven price for the position on the call side is $105 +0.57 = $105.57
4. The breakeven price for the position on the put side is $85 -.0.57 = $84.43

Set alerts for both the long call strike as well as the short call strike and do the same for the put strikes. This will keep you alert as to when to close the position. Ideally, we want to close the position at the middle strike being tested.

The strategy result provides three choices to exit the trade.

1. To sell the position once 100% profit is achieved (or whatever profit you deem acceptable).
2. To sell the position once it hits your loss threshold as determined by personal risk – this will happen with extreme movement.

To sell the position 18-21 days before expiration. If all is going well and you have decided to hold the trade into closer to the end of expiration, consider at least take some of the position off, as risks tend to rise the closer we are to expiration. (I have had many a trade go sideways by taking it down to the wire and not capturing gains, so I do not advise this).

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