Chipotle Mexican Grill has not simply led its restaurant industry group in recent years. The large-cap retail and consumer spending play has outperformed the stock market sharply. Thus, today's column features an unbalanced butterfly trade using options in CMG stock.
After a 50-for-1 stock split, CMG stock still maintains an excellent price performance record and strong group leadership. Nevertheless, shares took a dip below the 50-day moving average. This might sit as a current attractive buying area, if Chipotle holds support.
Meanwhile, current upside resistance looks like 70 for CMG stock today.
So as an options trader, I would like to position for an upside move back to 70. But, I also want to limit exposure if the chart prices dip into deeper potential levels of buying support.
Since its breakout past a split-adjusted 18.20 buy point from a deep cup with handle in early May 2020, CMG stock has rallied 281%. Over the same time frame, the S&P 500 has gained 89%.
When we consider an unbalanced call butterfly, consider this premise. First, prices potentially rise, but not past resistance through the weaker months in the market. Generally speaking, summertime can present price ranges in charts of stocks.
The unbalanced call butterfly, at first, looks like a standard butterfly. That is, a long call spread and a short call spread share a strike price. With some exceptions, the short call spread carries higher weight. This means that we are collecting credits on the short call spread to pay for the position at a favorable strike.
CMG Stock And The Setup
Let's structure this trade in CMG stock in this fashion:
- Buy to open 1 CMG Aug. 16-expiration call, 60 strike price
- Sell to open 3 CMG Aug. 16 70 calls
- Buy to open 2 CMG Aug. 16 75 calls
Total debit of $2.73 per set of contracts, based on recent trading, means this is the total risk for the position. Please note the difference in the formation of this trade in CMG stock. First, we have one long call spread and two short call spreads, both sharing the 70 strike.
Notice, also, that the width of the long call spread is twice as wide as the short call spread in CMG stock. This makes the risk only the debit for the trade and does not require any margin.
Risk Vs. Reward
The break-even price is $62.73 and the total profit available is calculated this way. Take the width of the long spread ($10) less the cost of the entire butterfly ($2.73), which means a trader can see $7.27 of upside per set of contracts (less commissions). Our goal will be to close the trade as it tests 70, or right where we have positioned the middle call strike and the current resistance.
The ideal strategy result gives us three choices to exit the trade. One, we sell the spread once it carries an acceptable profit, or around 100% (though it is often more) for me with butterflies. Two, sell the spread once it hits your loss threshold as determined by personal risk. And finally, sell the spread into the week before expiration, if all is going well. I have had many a trade go sideways taking it down to the wire and not yet capturing gains.
Defending The Trade In CMG Stock
Stock hunting using fundamental and price strength within the IBD methodology is where I firmly plant myself under the backdrop of the current economic backdrop. I use technical analysis to find ideal buying opportunities in conjunction with the tools for strength seen on IBD.
The goal of taking the unbalanced butterfly? Take advantage of the probability of price to sit in the range over the next 50 days near the middle strike of our butterflies. We sell strikes further out in CMG stock to finance our position.
Let's now identify key chart levels. The monthly resistance zone sits right around 70 The support sits near $60 — which should bring buyers to the chart
Scenarios for the Chipotle Mexican Grill Butterfly Trade
- CMG stock falls below $60 or rises above $75. Our butterfly loses much of its value
- The stock sits in its current range between $60 and $70. Thus, our butterfly expands in price
As with all trades, consider what you like about holding the position in the first place and consider your risk carefully.
Be patient and allow price action to move around a range of your stops.
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
