Hello, Power Profit Traders!
Is there a way to trade options regardless of market direction? The answer is YES!
Utilizing technical analysis tools and following general stock trends are helpful in determining if a trend is bullish or bearish. Events, however, like FDA approvals on pharmaceutical companies, and, more commonly, earnings reporting every quarter, can create uncertainty about the stock’s next move.
Earnings events can create high demand in options due to speculation and stock hedging. This high demand can cause a stock’s price to move opposite of what your technical analysis may otherwise suggest.
When the direction of a stock’s price becomes questionable, a directional trade becomes a coin toss – leaving you with a 50/50 shot!
Straddle trading takes the guess work out. Straddles can profit if the stock’s price rises OR falls on speculation.
The Straddle
Buying a call option is a bullish, directional trade and benefits when the stock’s price rises. Alternatively, when a trader has a bearish posture, a put option is bought to benefit from falling stock prices.
Combining a call and put trade with the same strike price and same expiration creates a Straddle trade. Because a call and put are being purchased together, the cost of the investment is much higher than buying a single contract by itself. All this means is that the stock’s price can go up or down to be successful, but a stronger move is typically required.
(Straddle example: WMT Jul 22, $124 call and $124 put)
In the example above, the bullish call option would cost $3.08 by itself. Adding the $2.83 put contract, creating a Straddle, would bring the combined cost to $5.91.
Profiting from Straddles
Calls and puts both have extrinsic value (time value) built into their premiums. Since time takes a toll on an option’s premium, your profit potential on a Straddle is best when the stock moves solidly sooner than later.
To calculate a Straddle’s break even point at expiration, simply add the combined cost of the trade to the strike price for upside break even, and then subtract the cost from the strike price for downside break even.
In our example above, the upside break even is $129.91, and the downside break even is $118.09 illustrated by the graph below.
(Straddle b/e points denoted by black line, at expiration)
From the graph above you can see from the red, blue and green lines that Straddles can be profitable before the options expire, with less price movement.
Operation Surge Strike
Don’t miss out!
Event trades occur all the time. I talk specifically about IV Surge Events each week, which includes opportunities for Straddle trading. Then, members of Operation Surge Strike are sent alerts for those event trades. Since earnings occur four times per year, well…the opportunities just keep on coming!
Click here to find out more about BRUTUS, the software I use to identify IV Surge Events, and the possibilities of using Straddles for those events.
I’ll see you soon!
Tom Gentile
America’s #1 Pattern Trader
