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Example Income Trade in CAT

One of my trading resolutions for 2011 was to significantly improve on my option income trading setups. This area of options trading is a particular weakness for me, as I tend to play around on the "gamma knife edge" and I like to hold onto positions much longer than needed when it comes to non-directional trades.

So here's a trade I was looking at in CAT. They've got earnings out of the way and just completed the $100 roll, so I'm expecting some chop and consolidation around these levels. So how does one structure risk here?

Well, I was looking at 100 call calendars, but after asking Seth Freudberg at SMB, he suggested a March 90/100/110 call butterfly instead due to volatility skew issues.

So we're going to papertrade and blog it.

The Trade Setup

Here's the risk profile:

Here's the risk management strategy:

If 20% of the debit is realized, close the trade for a profit.

If 10% of the debit is a loss, roll the closest side out to a condor.

If the stock tags 95 or 105, roll closest side out to a condor.

Buy a put/call as a delta hedge when necesary.

Let's see how it works out!

by Steven Place

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