Following another crippling week for the broader averages, an early gap, relief bounce in the market was quickly ignored in the influential financial sector (XLF) Monday. The group quickly took to its usual-of-late position of market laggard and potential bearish canary with many names (GS, MS, BAC) in jeopardy of breaking a grizzly flag pattern popular with its rank and file.
Amongst the most pressured, Dow constituent JPMorgan Chase (JPM) has seen heavy option volume intraday with puts trading over calls by a margin of 1.2-to-1.0. Most active, one or more traders look to have established an out-of-the money long put butterfly using December 18/23/28 strikes on 5,000 contracts. A handful of prints showed up around the first hour of trade for a net debit in the eyeballed neighborhood of $0.37 to $0.40 per spread.
Figure 1: JPMorgan Chase (JPM) Long OTM Butterfly
This type of long butterfly can, to a certain extent, act as a partial hedge for a bullish holding, but it’s far from an authoritative and concrete fix. As the risk graph in Figure 1 illustrates on a 10 contract (2% sizing on 20K portfolio) illustration, if shares of JPM were to go beyond the middle shorted 23 strike or worse yet, below the 18 put, this trader would not be servicing his or her existing (bullish) risk very effectively.
Also a potential menace using this “bearish, but let’s not break the bank” position as a hedge versus its use as a standalone strategy, is if shares move quickly towards the middle strike any expected profits will also likely be reduced. Were this too occur, what’s currently a long vega strategy would tilt into a short vega spread with negative implied volatility risk. And when there’s a good deal of time on the clock remaining and option premiums likely to spike higher during a steep drop in stock price; the net result would be a butterfly trading for less money in the open market prior to any wished-for, unwrapped gifts of $23 found at expiration.
Chris Tyler
Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate
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The information offered here is based upon Christopher Tyler’s observations and strictly intended for educational purposes only, the use of which is the responsibility of the individual.
