Taiwan Semiconductor, also known as TSMC, is one stock that has been showing strong accumulation. With the market looking very strong, investors might consider a "target strike butterfly" with this chipmaking giant.
The idea with the trade is that you pick a spot on the chart that you think a stock might get to in the next few weeks. Then set the butterfly trade around that strike. The ideal scenario is that the stock pins that strike right at expiration.
Let's walk through an example. If TSMC breaks out above its all-time high at 248.28, it could head up to 260, so you would center the butterfly around that price.
Butterfly spreads involve three different option strikes, all within the same expiration date, and can be created using either calls or puts. By trading a butterfly with a bullish bias, we can place the trade cheaply and also have a large potential payoff.
Three Different Price Options
Here's how you might conduct the trade. First, say you buy one Aug. 15 call at 250, which costs roughly $3.70 a share this morning. Then you sell two Aug. 15 calls at 260 for $1.55 a share. This is our "target." Last, you buy another Aug. 15 call at 270 for 65 cents a share.
This trade only costs around $125 per spread but has a payoff potential of $875. That maximum profit scenario occurs if TSMC is right at 260 at expiration on Aug. 15. The profit comes from the 250 call while the calls at 260 and 270 expire worthless.
The maximum loss on the trade is equal to the premium paid of around $125 per contract. This would occur anywhere below 250 or above 270.
To calculate the $875 maximum profit, take the width of the butterfly, which is 10 times $100, less the $125 premium paid.
Taking a low-risk trade like this can be one way to participate in any further rally without risking too much capital.
TSMC Stock: No Earnings Risk
TSMC has already reported second-quarter results, so there would be no earnings risk with this trade.
According to IBD Stock Checkup from Investor's Business Daily, TSMC stock ranks first in its group. It has a best-possible Composite Rating of 99, an EPS Rating of 98 and a Relative Strength Rating of 89.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
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 X/Twitter at @OptiontradinIQ
