NKE has sold off towards the $85 mid-point of the put butterfly that we initiated at the end of September following the massive gap higher as a result of better than expected earnings. At the time, we expected the stock to consolidate some of the gains, and wanted to place a trade that would take advantage of a decline in implied volatility. With only 4 days left until expiration, the butterfly is trading about 2.50 on the screens, vs. our cost basis of $1.75. We debated closing it here and taking those gains in case we’re near an oversold bounce in the market, but we decided to watch it a little longer, and here’s why:
The way the ITM butterfly works is there’s the intrinsic value of the fly versus the mark to market value. The mark to market value is 2.50. The intrinsic value of this with the stock at 86.50 is 3.50. That means that if the stock did nothing from here until expiration Friday afternoon, the structure would collect 1.00 in decay.
Obviosuly, the likelihood of the stock doing nothing from now until Friday is not high. So what that dollar difference does is allows us a little leeway in not panicking about an oversold bounce. We could watch NKE bounce higher by a dollar between now and Friday and still be able to get out of the trade for what we could now.
Conversely, it allows us a look to see if the stock can get to our mid point at 85 where we could see bigger gains. Because of that, we’re sitting on it right now, but if the market reverses hard higher, we’d likely make a move, and if the market sold off even more where 85 and lower is in picture, we’d also likely make a move.
Last month I initiated a trade in Nike (NKE) that would help finance the purchase of longer dated calls in anticipation of a potential breakout following last night’s fiscal Q1 earnings (read here). The thesis from Aug 19th was fairly simple, after such a long consolidation, the slightest bit of good news could cause a fairly substantial breakout. Well, the idea was correct, as the stock is making new all time highs this morning up more than 10%, but the execution and timing of my trade was horrible. A couple weeks ago after the stock broke out above by my strikes I closed the position for a small gain as I ran the risk of the trade turning into a loser if in fact the stock ran too far to fast (read here).
Don’t let anyone tell you that trading is NOT hard, as sometimes in an effort to manage risk capital in event driven trades I out smart myself, which was very much the situation with NKE over the last month.
After today’s move, it seems that the breakout is a bit overdone near-term and the highest probability over the next few weeks would be for the stock to consolidate some of these gains. This is where trading this view with options makes a lot more sense than trying to thread the needle with a call calendar on a directional play as I did back in August.
So here is the trade, playing for a near term consolidation in the middle of the last week’s range (basically $79 to $89):
TRADE: NKE ($88.35) Buy to Open Oct 90/85/80 Put Butterfly for 1.75
-Buy 1 Oct 90 Put for 2.55
-Sell 3 Oct 85 Puts at .44 each or .88 total
-Buy 1 Oct 80 Put for .08
Break-even on Oct Expiration:
Profits: gains of up to 3.25 between 81.75 and 88.25, max gain of 3.25 at 85
Losses: up to 1.75 between 8o and 81.75 and between 88.25 and 90, with max loss of 1.75 below 80 and above 90
This is essentially a short of the stock with a target of $85. The nice thing about this structure vs. shorting the stock is that if the stock squeezes higher above $90 the most that can be lost is $1.75. The sweet spot of the trade is at $85 and we’d likely take the trade off if the stock reverses towards that area quickly.