Taiwan Semiconductor, which just reported earnings, moved three times more than the expected move. With hype abounding, let's consider an options trade in Taiwan Semiconductor stock and add a twist.
Every time this stock has moved aggressively like this, we have watched the chart fill its gap. Then, we have seen Taiwan Semiconductor stock rotate lower before settling in on a new base and resuming upside. For this reason, I have used an unusual positioning. That is, at least for me, I choose a directional trade that serves as a "mean reversion trade" to the breakout with minimal risk exposure and strong potential for gains.
So we will use a put option butterfly spread trade, with a twist.
When we position with butterflies, we must consider our position size and lean into a smaller size. Why? The probabilities of success are slanted away from us.
When shocks come, we are well rewarded. But when the moves are undersized, we are not penalized heavily.
As always, we assume that we don't know the direction. However, we are able to estimate the magnitude of the move using the ATR (average true range, measured on the weekly chart) and the implied moves that the market makers have priced into the move over the months ahead.
Taiwan Semiconductor Stock: The Trade
The long put butterfly gets positioned so the 'long wing' of the trade gives us a likelihood of returns, while using the short wing to finance part of the trade.
This long put butterfly holds a single long put spread (a bearish position) and two short put spreads (a bullish position) that share the middle strike. Please notice the side that holds the short put spread is tighter so that risk is bounded and there is no need for additional margin.
- Buy to open 1 TSM Dec. 20-expiring put option, 190 strike price
- Sell to open 3 TSM Dec. 20 180 puts
- Buy to open 2 TSM Dec. 20 175 puts
The put butterfly above will cost $0.73 (the maximum loss for this position), or $73 per set of put contracts, based on recent trading. This makes the max profit $190 - $180 - $0.73 = $9.27 (outside of commissions), or $927. Total profits will begin to erode if TSM stays below 180. Our maximum exposure, the cost of the butterfly, also serves as the maximum risk.
The goal of taking long butterflies like the one above is to take advantage of higher implied volatility as the undercurrent of markets shifts so that we can participate in an outsized move in either direction.
Trade Management
After breaking to new highs, Taiwan Semiconductor stock has the statistical likelihood of filling its gap. This baseline support is near 190 with much of the volume crowding around 180. Therefore, I chose the middle strike as the sweet spot for potential maximum returns.
The strategy result provides three choices to exit the trade. One, sell the butterfly once it gets to an acceptable profit margin for you. I customarily look for 100%-300% profit for these kinds of trades. Two, sell the spreads once it hits your loss threshold as determined by personal risk. This will happen with extreme movement. I customarily look at about 65%, although depending on my size, I will choose 50%.
Finally, sell the butterfly spreads in Taiwan Semi into the week before expiration, if all is going well and you have decided to hold the trade into closer to the end of expiration.
I have had many a trade go sideways taking it down to the wire and not capturing gains, so I do not advise this third choice.
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
