Many of the trading strategies I have shown you have been Directional Trades. That means the option position requires the underlying stock or ETF to make a particular move in price – either up or down – for the trade to work.
And that’s exactly what makes directional trades so challenging – trying to predict which way a potential trade will go is difficult. You can plan your trades carefully, follow your rules to the letter, and still the markets can intervene, turning a perfectly good prediction about a stock’s direction into a losing trade.
What’s more, indecision about a stock’s direction – and whether you want to buy calls or puts – can delay your trade, causing you to miss out on your predicted move.
How would you like a strategy that allows you to place a trade that doesn’t CARE which way it moves, just so long as it moves?
That’s just what I’m going to show you today…
Profit No Matter Which Way a Stock Moves
Non-Directional Traders don’t need to worry about making predictions based on complex market data, pages and pages of stock charts, or anything else. Non-Directional Traders make trades to benefit no matter which direction a stock moves… so long as it moves.
How? You might think you need to take two separate trades, one a long call and the other a long put.
That’s almost correct…
The Straddle is a non-directional trading strategy that incorporates buying a call option and a put option on the same stock with the same strike and the same expiration.
A Straddle allows you to have a bearish and bullish play on a stock at the same time, with each acting as a hedge or insurance against the other.
So long as the underlying stock moves up or down in a big enough price move to cover the cost of the trade.
How do you counter or prevent getting into a trade where the stock doesn’t move? You want to take an option trade on a stock that has what’s called a catalyst for a move coming up in the near future.
A catalyst is a reason. There has to be a reason for traders to make a decision to either buy the stock or sell the stock and do so in a fashion that causes the price to move higher or lower.
What types of events or announcements can a stock make that causes a big move one way or the other?
- A pending FDA approval for a new drug
- The hiring or firing of their CEO
- An upcoming earnings report
- The launch of a new product
Now, I should point out that the cost of a Straddle is considerably more than a straight bearish or bullish options play – because instead of just buying one option, you are buying two. Since cost is risk, the straddle trade has an increased price risk over the directional option trade because of this.
But your odds of making money are greater.
Look at it this way…
The underlying stock can do one of three things: Move up, move down, or move sideways. So with a directional options trade, you have a 1 in 3 chance of the trade working in your favor.
But with a non-directional trade, you have a 2 in 3 chance of making money because you can profit if the stock moves up OR down.
Of course, if the stock stays stagnant, both Theta, (time value) and intrinsic value will come out of both options, and losses happen rather quickly.
Let me show you a quick example…
As an example, let’s take a look at Apple Inc. (NASDAQ:AAPL). We’re going to use the company’s next earnings, due on October 27, as our catalyst. And whether it is before market open or after market close, I want to be out of the Straddle by close of market October 26 (I’ll show you why in a moment).
My option analysis tools can tell me a great deal of information on about behavior of stocks before and after their earnings over the last four earnings reports.
AAPL has beaten the actual estimate eight out of the last eight earnings. See below:
My option analysis tools also tell me what AAPL has done by way of a percentage price move prior to the last four earnings. See below:
It shows an increase in price on four of the last four earnings. The percentage shown is for the four days prior to the earnings report (which is why we want to be out by October 26, before the earnings hit).
The next graphic will show you the price move percentage after the earnings announcement for those same four earnings reports. See below:
As you can see, the move in AAPL had a 50/50 split between positive and negative price moves. This graphic represents the move of the stock from before the earnings and the day of (if Before Market Open – BMO) or the day after (if After Market Close – AMC).
Even though AAPL has beat their earnings expectations eight out of the last eight times, you can see that didn’t always mean the stock was going to go higher the day following its earnings announcement. That could be for a variety of reasons – perhaps they beat earnings, but missed on revenues, or revised projections downward for the next quarter, or both.
The thing to know is that a positive beat doesn’t guarantee a positive post-earnings move… and that’s perfectly fine for the Non-Directional Trader – any move is a potentially profitable one.
The goal of this opportunity is to get a run up or down in the stock prior to the earnings and get out the day before. In other words, we’re playing the run up before earnings rather than the earnings themselves.
Now let’s look at the options chain:
The straddle is constructed with a call and a put with the same expiration and the same at-the-money strike price (it may end up that the strikes are slightly in or out of the money as it is rare the stock price is exactly the same as the strikes).
The current price on AAPL is roughly $112.29, so the closest strike is the $112 call and put.
Here is where the cost of the straddle can be an issue – at $8.25 on a per-contract basis, the Straddle is significantly more expensive than just buying the call or the put. But just as with our “loophole trades,” even though you are buying both it is still considered a single transaction by your broker (which means you’re only charged a single commission).
Now, the challenge of this trade is that AAPL needs to make a move prior to expiration of $8.23 to break even. That may seem like a daunting challenge, but if you look at your charts on AAPL, you will see that 8.23+ point price moves have indeed happened, and have done so in a month’s time.
Now, this may not be a strategy where you are looking for a 100% return. You may have to settle for a 50% ROI. Set a profit target goal and also be willing to take what profit you can based on what your trade plan dictates.
Here’s your trading lesson summary:
|The Straddle is a non-directional trading strategy that can profit no matter which way a stock moves… so long as it moves.
- Find a stock with an upcoming catalyst – any reason for it to move up or down.
- Buy an at-the-money call and an at-the-money put with the same strike price and expiration.
- This strategy may limit your returns, and 100% isn’t always possible because of the low-risk nature of the trade. So be sure to set your profit targets and stick with them.