Another Freight Train Play
- stevenplace
- September 28th, 2010
You know you want to.
There’s nothing sexier than calling a top in a stock or a market. If you can do this, you will be invited to all the fancy dinner parties to tell your tales of adventure; you will get “Tepper’d” by the media as endless TV requests come pouring into your inbox; Jim Chanos will be calling your cell phone asking for advice…
It’s really not that fun, but some people need to have their ego involved in their trades. While I don’t recommend that strategy whatsoever, I can provide a way to structure risk so when you are wrong (and you will be), the loss will be minimal.
Take BIDU for example:
Parabolic Much?
Clearly the name has ended up a little “extended” as it has seen a parabolic move on increasing volume. Valuations aside, many technical indicators are screaming “overbought” here. Would I short this? Absolutely not– but you can pick up some moderate short exposure using an out of the money butterfly buy.
The trade would be split up into three parts:
-> Buy 1 Oct 100 Put
-> Sell -2 Oct 95 Puts
-> Buy 1 Oct 90 Put
This is known as a butterfly spread. It is a limited risk, limited reward play where the profit is maxed out if the stock closes near the sold strike at expiration, and it is a loss if it closes outside the bought strikes.
Currently the total risk for this trade is about .70– and the average reward is about 3x that. If BIDU rips higher, you’re only out the debit you paid, but if it retraces 10-20% you will see a nice gain on your position. The tradeoff here is that if BIDU crashes, it will swing through the entire position and you will be left with a loser, so if you think BIDU is going to 50 in a week, well– call your boy Chanos and buy some puts straight up.
The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.
Tickers: bidu
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