-----Original Message-----
From: Christie H.
Subject: Regarding Possible Trade in SLW
Date: June 20, 2016
Good Morning Robb and Corey:
I was wondering...what do you think about SLW...a Call Butterfly, strikes either 20.5/21.5/22.5 or 20/21/22 that expires THIS FRIDAY??
I am questioning it a little because it gapped down just a little bit and it had a gap up on June 8, so it kind of looks like a small island gap, but not sure?
Thank you,
Christie
-----Reply Message-----
Hi Christie,
A Butterfly (and Condor) are not necessarily sideways trades, but are really long/short volatility plays.
The best way that I can illustrate this is to use a sports betting analogy. In sports, there is an over/under points bet that is very popular. For example, for last night’s NBA Finals game, the over/under bet was 208 points total for the two teams. Of course, everyone knows that both teams are going to score points. The question that the bid/ask bet asks is, "How many points are they going to score together?"
In trading, everyone knows that Silver Wheaton (SLW) is going to move around, but the important question is, "How much is SLW going to move?"
- When you go long a straddle or strangle, you are essentially betting the over that volatility (the "score") will be higher than expected – since volatility expectations (i.e., Implied Volatility) are built into option prices.
- When you chose a butterfly, condor or short straddle, you are basically betting the under that volatility (the "score") will be lower than market expectations.
With your proposed SLW Butterfly (basically, a play on precious metals), the question is, "Will the movement of SLW be lower than market expectations this week?"
If you were to compare last week’s options against this week’s options, then you would see a big difference in values – since the Brexit vote this Thursday is expected to create huge volatility in all asset classes, including precious metals. So, the play that you are making (the SLW Butterfly) is a bet on the markets not moving as much as expected this week with the Brexit vote.
The Butterfly that you are looking at is a very reasonable trade to make since there is a defined amount of small risk and a good reward/risk potential outcome. As long as you are position-sized correctly, then the trade is fine. Of course, the choice of whether to take the trade or not is, as always, yours alone to make.
Thanks,
Robb
* NOTE: Some original wording may have been modified for legibility and/or clarification
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