Eli Lilly stock has been on an incredible run this year, but is starting to look a bit extended at these levels.
Today, I want to look at a strategy that will profit if Eli Lilly stock pulls back into the 810-to-890 range between now and Aug. 16.
With the stock trading around 903, that represents a drop of between around 1% and 10%.
The strategy is called a broken wing butterfly and we'll use puts because the strikes will 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.
Eli Lilly Stock Trade Worked Before
The last couple of times we have looked at this strategy on Eli Lilly stock, it has worked well.
Let's take a look at how a broken wing butterfly trade might be set up.
Buy 1 Aug. 16, 790 put at 5.85
Sell 2 Aug. 16, 850 puts at 17
Buy 1 Aug, 16, 900 put at 35.80
Notice that the upper strike put is 50 points away from the middle put, and the lower put is 60 points away.
This broken wing butterfly trade can be placed for a debit of around $765, which is also the maximum risk on the upside.
Max Profit On Eli Lilly Stock Trade $4,265
The maximum risk on the downside is $1,765 with the maximum profit occurring at a price of 850 and is $4,265.
The ideal scenario for the trade is that Lilly stays flat initially and then slowly drifts lower to close around 850 at expiration. The total profit zone is between 810 and 890.
Because the trade has a delta of -4, it has a slight bearish bias to start.
In terms of risk management, I would set a stop loss of 20% of the capital at risk, or if Eli Lilly stock broke below 810.
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 X/Twitter at @OptiontradinIQ
