Xilinx (XLNX) has been a hot stock lately, rallying from 130 in early June to 220 in November. Its 50% gain in the fourth quarter so far tramples over a 9% move up by the S&P 500.
Perhaps now the leading tech stock needs to go through some sideways consolidation before it can start the next leg of the rally. If that occurs, traders might like to look at a butterfly-spread option trade on XLNX stock.
Butterfly spreads profit when the stock stays within a defined range, ideally with an associated drop in implied volatility.
Xilinx stock is currently showing an implied volatility percentile of 98%, making it an ideal candidate for a butterfly spread.
A Butterfly Option Trade In Xilinx Stock
A typical butterfly would be constructed as follows:
- Buy 1 in-the-money call or put
- Sell 2 at-the-money calls or puts
- Buy 1 out-of-the-money call or put
Here is how that might look on XLNX stock. Let’s place it slightly below the current price in case the stock pulls back from these overbought levels.
- Buy 1 Dec. 17-expiring 200 put @ 8.70
- Sell 2 Dec. 17 210 puts @ 11.70
- Buy 1 Dec. 17, 220 put @ 16.25
Risk Vs. Reward
The total cost of the trade is $155 for a 100-share block, and that is the maximum loss potential.
The maximum gain is $845. Calculate this by taking the difference in strike prices less the premium paid ($1,000 less $155).
The breakeven prices for the stock are 201.55 and 218.45.
A butterfly trade has a tent-like shape with the potential for large profits around the short strike. It is important to keep in mind that achieving the maximum profit is a rare occurrence.
As this trade in Xilinx stock involves a very favorable risk to reward ratio, I would look to hold the butterfly spread until it’s close to its expiration date.
Butterfly spreads can be a bit confusing for beginners, so it is best to paper trade this and see how it performs.
According to IBD Stock Checkup, XLNX stock is ranked 9th in its fabless semiconductor group and has a strong Composite Rating of 98, and EPS Rating of 82 and a Relative Strength Rating of 96.
Earnings are set for the end of January, so this trade should have no earnings risk.
Please remember that options are risky, and investors can lose 100% of their investment.
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 Twitter at @OptiontradinIQ.
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