Target (TGT) has been on a monster rally for the last few months. The stock ranks as No. 2 in the Retail-Major Disc Chains Group with a Composite Rating of 97, an EPS Rating of 94 and a Relative Strength Rating of 89.
Such a strong stock may not pull back very far in the near term. It could possible drift sideways or slightly higher. So, an option trade idea that will profit if TGT stays below 290, is a broken wing butterfly.
A broken wing butterfly using calls is a trade that can be set up with little risk on the downside and a nice profit zone on the upside.
The catch? Understand the risk on the upside if TGT makes a big move higher. So, this is a neutral to slightly bullish trade.
Very bullish traders would not enter this trade.
Target Stock And A Broken Wing Butterfly
Let’s take a look at how a broken wing butterfly trade might be set up on TGT stock.
- Buy 1 Aug. 20-expiring 270 call @ 3.15
- Sell 2 Aug. 20 280 call @ 1.65
- Buy 1 Aug. 20 300 call @ 0.50
Notice that we set up the lower-priced strike call 10 points away from the middle call and the upper-priced call 20 points away.
This broken wing butterfly trade will cost $35 and that is the maximum potential loss if the stock trades below a price of 270. If TGT stock ends below 270, all the calls expire worthless, and the trader loses the $35 premium paid.
Maximum Loss, Maximum Gain
On the upside, the maximum loss can be calculated by taking the width between the first two strikes (10) multiplied by 100 and adding the premium paid (35). That gives us 10 x 100 + 35 = $1,035.
Calculate the maximum gain this way: 10 x 100 — 35 = $965. You would achieve this gain only if Target stock expired right at 280.
The ideal scenario for the trade is that TGT stays below 280 until expiration. The risk on the trade is that TGT shoots significantly higher, particularly early in the trade.
For those with a neutral to slightly bullish outlook, a broken wing butterfly could be a nice way to trade Target stock. In terms of risk management, I would set a stop loss if TGT broke above 290.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions. Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
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