Shopify has pulled back and, so far, has held the 200-day moving average as support.
Today, we are looking at a strategy that has the potential to generate a healthy return provided Shopify stock stays above 50.
The strategy is called a broken wing butterfly, and we will use puts because the strikes will all be out of the money. Doing this minimizes assignment risk.
The wings are placed an equal distance from the short strike for a regular butterfly trade. We leave a larger gap on a particular side with a broken wing butterfly.
As a result, broken wing butterflies have less risk on one side and more risk on the opposite side.
Let's look at how we can set up a broken wing butterfly trade on Shopify stock.
- Buy 1 Oct. 20, 45 put @ 0.30
- Sell 2 Oct. 20, 52 put @ 1.75
- Buy 1 Oct. 20, 55 put @ 3.20
Notice that the upper strike put is 3 points away from the middle, and the lower put is 7 points away.
Ideal Target For SHOP Trade: 52
This broken wing butterfly trade can be placed for close to zero cost, with maximum risk of $400.
If Shopify closes above 55, all the puts expire worthless, and the trader has a flat return, or a slight profit if the trade is entered for a credit.
On the downside, the maximum loss can be calculated by taking the difference in widths between the strikes (7-3) multiplied by 100 and subtracting (or adding) any premium received (or paid).
That gives us 4 x 100 — 0 = $400.
The ideal scenario for the trade is for Shopify stock to stay above 52 and finish right at 52 on the expiration date.
Trade About Equal To Owning Nine Shares Of Shopify
Because the trade starts with a delta of 9, this strategy is bullish. The initial exposure is roughly equivalent to owning nine shares of Shopify.
A broken wing butterfly could be an excellent way to trade Shopify for those with a neutral to bullish outlook.
I would set a stop loss of 20% of the capital at risk (0.20 x 400 = $80) or if SHOP stock broke below 49.
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
