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GAVIN McMASTER

As Long As McDonald's Stock Behaves, This Option Trade Will Hit It Off

McDonald's stock is forming a base and shows strong support at 260, not far below Friday's closing price.

Today, I want to look at a strategy with no risk on the upside and a healthy profit zone on the downside.

The strategy is called a broken wing butterfly. We'll use puts because the strikes will be all below the stock price. This helps to reduce assignment risk.

With a regular butterfly option trade, the wings are placed an equal distance from the short strike. But with a broken wing butterfly, we leave a larger gap on a particular side.

This results in less risk on one side and more risk on the opposite side.

Same Trade on McDonald's Stock Worked Before

The last couple of times we have looked at this strategy on McDonald's stock, it has worked well.

Let's take a look at how a broken wing butterfly trade might be set up on MCD stock.

  • Buy 1 March 17, 245 put @ 1.25
  • Sell 2 March 17, 255 put @ 2.80 each
  • Buy 1 March 17, 260 put @ 4.20

Notice that the upper strike put is 5 points away from the middle put, and the lower put is 10 points away.

This broken wing butterfly trade will result in a net credit of $15, which means there is no risk on the upside.

The worst that can happen is all the puts expire worthless, leaving the trader with a $15 return.

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On the downside, the maximum loss can be calculated by taking the width between the first two strikes (5) multiplied by 100, less the premium received.

That gives us 5 x 100 — 15 = $485.

The maximum gain can be calculated as 5 x 100 + 15 = $515.

Ideal Scenario For Broken Wing Butterfly

The ideal scenario for the trade is that McDonald's stock stays flat initially and then slowly drifts lower to close around 255 at expiration. The total profit zone is between 250 and 260.

Because the trade starts with delta of 3, it has a slight bullish bias to start. But that will flip to negative delta closer to expiry if the stock is still above 260.

In terms of risk management, I would set a stop loss of 20% of the capital at risk, or if McDonald's broke below 255.

A cash secured put trade on Etsy discussed Jan. 17 has reached its early profit target and can be closed. It could also be a good time to take early profits on this calendar spread on Netflix.

It's important to 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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