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

Using the broken-wing butterfly options strategy

Once a trader learns option basics, he often will forgo selling stock short in favor of buying a more limited-risk naked put. For the remainder of this article we will assume the option chain shown in "Chain gang" (below) that is based on volatility at 30.6% with 38 days until expiration.

In "Put it to 'em" (right), we see that when the stock is trading at $536, we can purchase the right to sell it at the 530 strike instead of selling the stock short. The cost of this put is $18.10 and we will control the same 100 shares of stock that we were looking to short.

When considering the sale of the stock, we had to put up $26,800, but the cost of one put contract trading at $18.10 will require an investment of only $1,810 ($18.10 per share * 100 shares per contract). Because of the lower cost of entry and substantially reduced risk, many traders prefer to purchase the put for $18.10. Obviously we would want to exercise that right only once the stock moves considerably in our direction.

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