• Market:  December 2006 Coffee (KCZ6)
• Tick value: 1 point = $375
• Option Expiration: 11/10/06   
• Trade Description: Bull call Butterfly spread
• Max Risk: $937.50
• Max Profit: $4687.50
• Risk vs. Reward Ratio 1:5

Buy one December 2006 Coffee 105 and 135 calls and at the same time sell two December 2006 Coffee 120 calls for a combined cost and risk of 2.50 points ($937.50) or less to open a position.

Technical / Fundamental Explanation
Coffee is usually one of the more volatile markets to trade. Over the course of this past summer we have seen volatility in this market move to a multi year low, as I pointed out on the chart below. When volatility is low it favors buying options, conversely when volatility is high it favors selling options short. Since coffee is now at multi year lows in terms of volatility we have a great opportunity to position long for most of the rest of this year with this trade. We are simply looking for this market to either rally back up to the upper resistance level or better yet break out above it. This trade is buying a near the money option and selling distant out of the money options to reduce the cost of the long option and since the long option. We get a very attractive 1 to 5 risk to reward ratio which means for each 1 dollar we are risking we are trying to make 5.

Profit Goal
Max profit assuming a 2.50 point fill is 12.50 points ($4687.50) and occurs at expiration with coffee trading at 120.

Risk Analysis
Max risk, before commissions and fees, and assuming a 2.50 point fill, is $937.50. This occurs at expiration with Coffee trading below 105 or above 135.

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

Disclaimer
Past performance is not indicative of future results. Trading futures and options is not suitable for everyone. There is a substantial risk of loss in trading futures and options.