McDonald's stock recently broke below the 200-day moving average, but yesterday found support around 242.50. Here's an option strategy on McDonald's stock with very little risk on the upside and a healthy profit zone on the downside.
Broken Wing Butterfly Trade On McDonald's Stock
The broken wing butterfly is similar to a regular butterfly option trade. The biggest difference is that rather than placing the "wings" an equal distance from the short strike price, there's a larger gap on a particular side.
The asymmetry makes for less risk on one side and more risk on the opposite side. This isn't the first broken wing butterfly trade on McDonald's stock for this column. Another broken wing butterfly example presented itself in July and is also covered in the video above.
In this case, we'll again use puts because the strikes will all be below the stock price. This helps to reduce assignment risk.
Let's take a look at how a broken wing butterfly trade might be set up on MCD stock now:
- Buy one Oct. 21-expiring 225 put at 1.60
- Sell two Oct. 21 235 puts at 3.25 each
- Buy one Oct. 21 240 put at 4.75
Notice that the upper strike of 240 is five points away from the middle-strike put with a 235 strike. You can think of it as a debit spread between 235 and 240. Meanwhile, the lower-strike put at 225 is 10 points away from the 235 short strike. This sets up a credit spread between 225 and 235 that more than pays for the debit spread.
Profit And Loss For The Trade
This setup for the broken wing butterfly on McDonald's stock brings in a credit of 15 cents share or $15 per contract. If MCD stock skyrockets from here, the worst that can happen is all the puts expire worthless and you keep the $15. That's what happen in the last broken wing butterfly example for McDonald's stock.
On the downside, calculate the maximum loss by taking the width between the first two strikes of 240 and 235 (5) multiplied by 100, less the premium received. That gives us 5 x 100 - 15 = $485.
The maximum gain is calculated similarly but with the premium received getting added. So 5 x 100 + 15 = $515 for the maximum gain.
The ideal scenario for the trade? MCD stock stays flat initially and then slowly drifts lower to close around 235 at expiration. The total profit zone is between 230 and 240.
As the trade in McDonald's stock starts with delta of 4, it has a slight bullish bias to start. But that will flip to negative delta closer to expiry if the stock is still above 240.
In terms of risk management, I would set a stop loss of 20% of the capital at risk, or if MCD broke below 230.
Options On Nike Stock Revisited
This bear call spread on Nike performed well. With earnings coming up, the Nike stock trade can be closed out ahead of time with a profit.
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
