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Options Trading: Use a Butterfly to Catch FAST Gains

Posted On January 16, 2018 12:36 pm
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Fastenal (FAST) manufactures construction supplies such as screws, bolts and studs. It sells mostly into heavy machine, railroad, framing and mining should be benefiting from improved economic activity across those sectors and any potential infrastructure spending. And it’s going to serve as a useful options trading lesson for today.

The company is set to report earnings on Wednesday, Jan. 17 before the market opens. Analysts are expecting revenue of $1.02 billion and EPS of $0.45 which are 14% and 8% increases over the year ago period.

But the company’s record is mixed, with several misses over the past 12 quarters.

And profits have been hurt by margin pressure, as the company has pushed top line growth through acquisitions and aggressive pricing.

I think new tax policy is not priced in, and should offset the margin issue, but the stock has already gained some 22 percent since its last report. It currently trades at a relatively rich 26 times forward earnings.

The current implied volatility is 68 percent, meaning the weekly options are pricing in approximately 4.9% or $2.70 movement in the three days following the report.

I want to be bullish, but I have a lower degree of confidence, and think the upside is limited.

Therefore, I am using a low cost butterfly with only half the typical allocation.

This will provide us with good profit potential while limiting risk in our options trading.

Action:

  • -Buy to open 4 contracts FAST Jan. (1/19) 55 Call
  • -Sell to open 8 contracts FAST Jan (1/19) 57.5 call
  • -Buy to open 4 contracts FAST Jan (1/19) 60 Call

For a Net Debit of $0.70 

Here is what the risk/reward profile of the trade looks like.

As you can see, if shares move up within the expected range towards $57.50, the butterfly spread will be worth $2.50 for over a 300% gain. That’s some nice, fast profits.

 Related: This Measure Lets You Predict the Next Recession

 

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About author

Steve Smith
Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.

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