Pure Storage is holding up well lately after a 22% jump in massive volume during the week ended Dec. 6. This action means we might make a nice profit with a unique long call butterfly trade in Pure Storage stock that runs through February.
In early December, Investor's Business Daily highlighted Pure Storage as an emerging new leader. The chart formations leave a fair bit of room for upside price action. However, current market action is somewhat rangebound, so buying call options outright could prove quite expensive.
In addition, the implied volatility within the option chains of Pure Storage stock further increases the cost of positioning using long calls only.
Today's setup, the long call butterfly, thus features a twist.
Pure Storage Stock: The Setup
A basic long call butterfly combines a long call spread trade with a short call spread. They share the same short strike in between the two long strikes. We often see this in options jargon shorthand as a 1 by 2 by 1 or 1x2x1 option position. Put another way, we set up the butterfly by going long one call strike, short two call strikes, and long one call strike with increasing strike prices along the way.
Our twist is as follows: Go long one call strike in Pure Storage stock. Then, we sell three call strikes, and finally buy two call strikes.
What does this achieve? We use premium collected for the short call spreads further out of the money to finance the long call spread that is closer to being in the money. The only reason we use a 1x3x2 trade structure is to help finance the price of the long call spread. Now, should this feel too cumbersome for you, the long call spread might be a better alternative.
Long Butterfly Trade Structure With A Twist
The long call butterfly with a twist consists of three spreads: one long call spread and two short call spreads that will finance a portion of the premium required for the long call spread:
- Buy to open 1 PSTG Feb. 21 call option with a 70 strike price
- Sell to open 3 PSTG Feb. 21 80 calls
- Buy to open 2 PSTG Feb. 21 85 calls
At the time of this writing, the premium debit (or cost) totaled $1.05, or $105 per set of option contracts. It represents the total risk of the position. Because prices seem to be moving around quite a bit, I would recommend trying to fill this in tranches. Consider placing an order at $.70 and another at $1.05 and leave it in the queue using GTC (good 'til cancel) orders to get better option prices in Pure Storage stock.
Calculate maximum profit as the distance between the strikes $70 and $80, or $10, minus the cost of the position ($1.05). We see a maximum gain of $8.95, or $895 per set of contracts, less commissions.
The keen eye will notice that the short call spreads are only $5 wide, whereas the long call spread is $10. I chose this design because I did not want to incur margin when placing the trade. My goal is to minimize risk while leaving upside opportunity to develop.
I also want to see Pure Storage stock reach 80 before options expire on Feb. 21, but no higher. This gives me the maximum profit allowable. Also, I do not want to see Pure Storage stock head lower.
Nor do I want to see prices above $81.05 (breakeven price) before February expiration.
Key Chart Levels
Current price resistance sits near 70. Our position in Pure Storage stock is dependent on a breakaway pattern showing in the near term as our weekly price charts continue to show us higher lows. Support on these longer time frames shows a breakout near 60. It might not be unusual for this chart to test that support before cresting back into resistance. This is also why I have positioned the trade as a '1x3x2,' which lowers the required debit to enter this trade.
Earnings are likely to arrive on or around Feb. 26, and the expiration of our options position comes before earnings. This removes a potential earnings jolt. An unusual block of 4,900 puts are sitting at 60 (our noted support line). This means Pure Storage stock could fade to that zone before bouncing.
The strategy result provides three choices to exit the trade. One, sell the entire call butterfly position once it gets to an acceptable profit margin for you. I customarily look for 100%-300% in the current environment of volatility. Two, sell the entire call butterfly position once it hits a loss threshold as determined by personal risk. I customarily look at about 65%, though depending on my size, I will choose 50%.
Three, sell the entire call butterfly position into the week before expiration, or in this case usually 10-12 days before the options expire on Feb. 21. We sell if all is going well and have decided to hold the trade closer to the end of expiration. Yet I have had many a trade go sideways down to the wire and not capture gains, so I do not advise this.
Anne-Marie Baiynd is a 20-year veteran trader of stocks, options and futures and is the author of "The Trading Book: A Complete Solution to Mastering Technical Systems and Trading Psychology." She holds no positions in the investments she writes about for IBD. You can find her on X at @AnneMarieTrades
