Arcángel de Jesús Montoya
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Arcángel de Jesús Montoya in Alexander Valtsev,

You Weekly Trade In 3D Systems Corporation

3D Systems Corporation jumped today by over 10% on an upgrade done by Merrill Lynch:

The stock gapped 10% higher and reached as high as $19.70 before the gain was eroded by heavy selling for the rest of the trading session. Now that we are late for the trade, how can we profit from it? We do not know where the stock is going tomorrow, whether it is going to crash or gap higher. I would not buy the stock now, even if I wanted to hold it for years. I would most likely average up or down, based on the auction in the coming week. However, I love the options. I particularly love selling calls in this case as they have become awfully expensive:

(Source: Google Finance)

The one-week straddle is worth 7% of the current market price (I used the $18 strike for calculation). This translates into an annual volatility of over 51%! This may seem high but historical volatility is actually higher than that (excluding data from the last two days):

(Source: Google Finance)

Hence, I want to have an exposure to volatility but I also want to make sure that I do lot lose my principle in the event the stock does not move. Therefore, a regular straddle would not do. What I have in mind is something called a short call butterfly. Practically, this strategy is executed in the following way: the trader shorts one in-the-money call, buys two at-the-money calls, and shorts one out-of-money call. You can choose any amount of contracts you want, as long as the 1-2-1 proportion remains unchanged. The beauty of this strategy is that: (1) it results in a net credit position (you get money upfront because you sell more expensive premiums than your buy) and (2) the risk is limited. With these particular one-week options you have another nice surprise: the risk-return relationship is heavily biased towards the sellers (that means you). You can confirm that yourself:

(Source: optionsprofitcalculator.com)

A trader getting into this trade will immediately get ~$79 credited to his/her account. In contrast with iron condor, this strategy is aimed at volatility. In fact, this strategy will only be profitable, if the stock moves at least 6.5% in either direction. This may not sound sexy but it is still cheaper than the straddle and you get the money upfront. In addition, you, as a trader, now what your maximum risk and return are beforehand. With this trade you are looking at a return of $79 per contract (100 shares) and maximum loss of $121 per contract (that is, $121 out of your account, not counting the net premium you would give away). In fact, if you bought a straddle, your maximum loss would well exceed $200 per contract.

Alternatively, you can do a short put butterfly but the risk-reward relationship is worse than with the calls, which have become very expensive today. I like my short call butterfly idea and I find it highly probable that the trade will end up in-the-money.

Please let me know what you think of this strategy.