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Another Freight Train Play

You know you want to.

There's nothing sexier than calling a top in a stock or a market. If you can do this, you will be invited to all the fancy dinner parties to tell your tales of adventure; you will get "Tepper'd" by the media as endless TV requests come pouring into your inbox; Jim Chanos will be calling your cell phone asking for advice...

It's really not that fun, but some people need to have their ego involved in their trades. While I don't recommend that strategy whatsoever, I can provide a way to structure risk so when you are wrong (and you will be), the loss will be minimal.

Take BIDU for example:

Parabolic Much?

Clearly the name has ended up a little "extended" as it has seen a parabolic move on increasing volume. Valuations aside, many technical indicators are screaming "overbought" here. Would I short this? Absolutely not-- but you can pick up some moderate short exposure using an out of the money butterfly buy.

The trade would be split up into three parts:

-> Buy 1 Oct 100 Put

-> Sell -2 Oct 95 Puts

-> Buy 1 Oct 90 Put

This is known as a butterfly spread. It is a limited risk, limited reward play where the profit is maxed out if the stock closes near the sold strike at expiration, and it is a loss if it closes outside the bought strikes.

Currently the total risk for this trade is about .70-- and the average reward is about 3x that. If BIDU rips higher, you're only out the debit you paid, but if it retraces 10-20% you will see a nice gain on your position. The tradeoff here is that if BIDU crashes, it will swing through the entire position and you will be left with a loser, so if you think BIDU is going to 50 in a week, well-- call your boy Chanos and buy some puts straight up.

by Steven Place

Steven Place is the founder and head trader at investingwithoptions.com/