We are quickly approaching the end of our series of articles on using an iron butterfly. This is because this coming Friday is options expiration and the mock trade we are following will come to an end. However, as fate would have it, our trade is at a very crucial point, which is a good example of what happens in the real world

Up until Friday of last week, our mock trade on Amgen (AMGN) was doing nicely. After reaching nearly $54 last Tuesday, Amgen started to fall back into its range. However, the stock market got a nice boost both Friday and Tuesday, sending the stock back up to resistance near $53-$54. Thus, with just days left before expiration, our trade is showing about a 50 percent loss. However, there are pros and cons to selling this late in the game.

First of all, by closing the trade, you will need to pay commissions and this could eat away any advantages of closing out early. However, if your view is that the stock is going to continue higher, than selling now would be the prudent choice. Like we discussed last week, you should have set a predetermined exit point, and this decision should tell you where to exit. Below is a risk graph of the trade through Tuesday’s trading.

Notice how the stock is still sitting below our max loss price of $55, but is above our breakeven price of $52.40. However, it wouldn’t take much of a drop in price to take Amgen to a point where we would breakeven on this trade. The stock has also run up into resistance, which could reject the shares going forward. If AMGN were to close at its current price of $53.62 on Friday, we would lose a total of $610 on this trade, not including commissions. However, we would have no commission cost at the back end unless we chose to close out the trade before expiration. Look below to see the week-to-week progress of this trade.

Jan. 21, 2003
AMGN Iron Butterfly
Stock Price: $51.59
Buy 5 Feb 40 Puts @ 0.2 = -$100
Sell 5 Feb 45 Puts @ 0.55 = $275
Sell 5 Feb 50 Calls @ 2.60 = $1300
Buy 5 Feb 55 Calls @ 0.55 = -$275
Total Credit = $1200
Max Risk = $1300
Downside Breakeven = 42.60
Upside Breakeven = 52.40

Jan. 28, 2003
AMGN Iron Butterfly
Stock Price: $50.87
5 Feb 40 Puts @ 0.10 = $50
5 Feb 45 Puts @ 0.35 = -$175
5 Feb 50 Calls @ 2.75 = -$1375
5 Feb 55 Calls @ 0.50 = $250
Total Credit = $1,200
Cost to Close Trade = $1,250
Current Loss = $50 (not including commissions
Max Risk = $1300
Downside Breakeven = 42.60 (at expiration)
Upside Breakeven = 52.40 (at expiration)

Feb. 4, 2003
AMGN Iron Butterfly
Stock Price: $51.83
5 Feb 40 Puts @ 0.00 = $0
5 Feb 45 Puts @ 0.20 = -$100
5 Feb 50 Calls @ 2.65 = -$1325
5 Feb 55 Calls @ 0.35 = $175
Total Credit = $1,200
Cost to Close Trade = $1,250
Current Loss = $50 (not including commissions
Max Risk = $1300
Downside Breakeven = 42.60 (at expiration)
Upside Breakeven = 52.40 (at expiration)

Feb. 11, 2003
AMGN Iron Butterfly
Stock Price: $53.45
5 Feb 40 Puts @ 0.00 = $0
5 Feb 45 Puts @ 0.10 = -$50
5 Feb 50 Calls @ 3.70 = -$1850
5 Feb 55 Calls @ 0.50 = $250
Total Credit = $1,200
Cost to Close Trade = $1,650
Current Loss = $450 (not including commissions)
Max Risk = $1300
Downside Breakeven = 42.60 (at expiration)
Upside Breakeven = 52.40 (at expiration)

Feb. 18, 2003
AMGN Iron Butterfly
Stock Price: $53.62
5 Feb 40 Puts @ 0.00 = $0
5 Feb 45 Puts @ 0.05 = -$25
5 Feb 50 Calls @ 3.70 = -$1850
5 Feb 55 Calls @ 0.15 = $75
Total Credit = $1,200
Cost to Close Trade = $1,800
Current Loss = $600 (not including commissions)
Max Risk = $1300
Downside Breakeven = 42.60 (at expiration)
Upside Breakeven = 52.40 (at expiration)

Basically, from this point forward, our trade will fluctuate in value dollar for dollar with the stock. This is because with just a few days left until expiration, there is very little time value left in the options. Technically, the past two days of advances for AMGN have been accompanied by less volume than the declining days. This is a bearish indicator, but we don’t have a lot of time for the bears to take hold of the stock.

The situation we are currently in is common and is the exact reason why we set an exit point before we enter the trade. If your exit point was half the reward, then you should be out of this trade. If your exit point was the upper strike price of $55, than you would still be in this trade. Each trader has a different risk tolerance, but the key is to stay true to yourself and follow your plan.


Jody Osborne
Senior Writer & Options Strategist
Optionetics.com ~ Your Options Education Site
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