An Iron Butterfly Spread on Shares of Canopy Growth Corporation

As you can see in the following graph, shares in Canopy Growth Corporation (WEED) have shot up in price since bottoming out at $6.58 in June 2017. This represents more than 600% growth to its recent peak at $44. Since then, WEED has slipped, falling to $29.50 before bouncing back and has been fluctuating in a range that could become a buffer zone for a while. If this is true, the situation could represent an opportunity to implement a strategy that takes advantage of the stock’s relative stability and, consequently, of the time decay of the option premium, which is very high right now with an implied volatility of over 80%.

Daily chart of WEED as at January 22, 2018 ($37.38)

Establishing an iron butterfly spread would allow us to profit from these conditions. It would not come as a surprise if the current pause turns out to be only temporary, so we choose an expiration of February 16, 2018.

Position

• Purchase of 10 call options WEED 180216 C 48 @ $0.50
  • Debit of $500
• Sale of 10 call options WEED 180216 C 38 @ $2.35
  • Credit of $2,350
• Sale of 10 put options WEED 180216 P 38 @ $3.50
  • Credit of $3,500
• Purchase of 10 put options  WEED 180216 P 28 at $0.40
  • Debit of $400
    • Total credit of $4,950
      

Profit and Loss Diagram for the Iron Butterfly Spread

As you can see in the above diagram, we will make a maximum profit of $4,950, derived from the total net credit received, if WEED closes exactly at the strike price of $38 when our options expire on February 16, 2018. This position will be profitable as long as the price of WEED stays within the two breakeven prices of $33.05 and $42.95. The strategy will generate losses on either side of these two breakeven prices, with a maximum loss of $5,050 below the strike of $28 and above the strike of $48. The maximum loss is the difference between the strikes of the call options and the put options less the net premium per share, multiplied by the size of 100 shares per contract and by the position of 10 contracts: ($10 – $4.95) x 100 x 10.

Intervention

In taking this position, we are counting on the stock price being relatively flat for a period of time, but there are no guarantees that this will occur. So as long as WEED stays between the two above-mentioned breakeven prices, we do not need to intervene in any way. However, should the price break through either of these levels in a major way, we would be in a precarious position and exposed to potentially large losses. Such a situation would force us to take defensive measures, closing the position and absorbing the loss.

Good luck with your trading, and have a good week!

The strategies presented in this blog are for information and training purposes only, and should not be interpreted as recommendations to buy or sell any security. As always, you should ensure that you are comfortable with the proposed scenarios and ready to assume all the risks before implementing an option strategy.