From the May 01, 2011 issue of Futures Magazine • Subscribe!

Ride bullish trends with unbalanced broken wing butterfly options

Options Strategy

Question: How can you ride the huge bullish trends in metals, while avoiding the often sharp and deep reversals?

Answer: Initiate an unbalanced broken wing butterfly.

There is a saying that trading is simple, but it is not easy. Another cliché that happens to work in markets is, "The trend is your friend." All a disciplined trader needs to do is unemotionally follow the trend and apply good risk management, and he will succeed. However, the longer a trend continues, the more nerve-racking it can be to hold a position. When a trade moves against you, it is natural to ask, "Am I buying the top?" or, "Am I selling the bottom?" Even the most seasoned trader can become fearful at the first sign of a pullback. A trend is just that — a trend. It is seldom a straight line. Even if you find a trend that is going in the right direction, you still could get in at the wrong time, and they all end at some point.

Imagine getting long the silver exchange trade fund SLV in late December or early January only to watch it fall 13% in a month (See "Timing is everything"). Naturally, you would think that you had bought the top. Disciplined traders rarely are willing to risk 13% of their capital in a trade. Most would be stopped out only to watch the market continue higher. This is frustrating and not uncommon, especially in the volatile metals sector that has experienced huge moves and often sharp corrections.

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Few traders can ride a bull or bear market position when the first sign of a reversal occurs, especially if they were tardy on the initial trend. We all can get spooked out as fear of losing can be a stronger emotion than the greed of riding a winner. Strong risk management allows you to stay in potentially profitable positions while protecting your downside. This can be accomplished through strategic options positions that can weather an economic tsunami in the wrong direction.

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