Education
Option Idea: Bear Put Butterfly Spread in the Gold Futures
By Derek Frey
Jan 10, 2007, 19:15

• Market:  April 2007 Gold (GCJ7)
• Tick value: 1 point = $100
• Option Expiration: 03/27/07   
• Trade Description: Bear put Butterfly spread
• Max Risk: $500
• Max Profit: $2000
• Risk reward ratio:  4:1

Buy one April 2007 Gold 600 put and at the same time sell two April 2007 Gold 575 puts, and buy one April 2007 Gold 550 put for a combined cost and risk of 5 points ($500) or less to open a position.

Technical / Fundamental Explanation
Gold has been one of the leaders of the commodity complex for some time now. It is still one of the leaders the only thing that has changed is the direction. Metals are expected to continue to trend lower over the first part of 2007. With the dramatic moves we have already seen this year, 2007 continues to look like volatility is going to be the theme of the year. This trade positions us short Gold and targets the market to move back towards strong support at $575. Bear in mind that we are not expecting the market to free fall down to that level but rather a slower more methodical trend lower. Looking at the chart below you can see that both the 8 and 21 day moving averages have fallen below the 50 day moving average confirming the sell signal. Using a butterfly has the benefit of keeping actual dollars at risk low while at the same time giving us a very wide range in which we can profit. This trade is profitable at expiration if gold is trading anywhere between $555 and $595.

Profit Goal
Max profit, assuming a 5 point fill, is 20 points ($2000) and occurs with Gold trading at $575 at expiration. Break even points are $595 and $555 which means we have a band of $40 dollars in which the trade can be profitable.

Risk Analysis
Max risk, before commissions and fees, and assuming a 5 point fill, is $500. This occurs at expiration with Gold trading below $550 or above $600.

Derek Frey is Head Trader at Odom & Frey Futures & Options.

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