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Saturday, May 16, 2009

Stock Option Straddles. Financial In the Money Edition

One way I have been able to profit from the volatility over the past 7 months is by using the option straddle strategy. A straddle is simply buying both the Call and the Put option contracts, and hoping that the stock swings in one direction by more than the cost of both contracts combined. As you'll see from the strategies below, the more volatile the underlying stock the higher the premium, this should make sense, and if it doesn't, this type of trading is most likely not for you. When I use an option straddle, I like to go 30-40 days out until expiration.
As we know financials are a very volatile sector therefore they make for good straddle positions. Below are 10 straddle strategies for financial stocks and ETF’s. You’ll most likely need to adjust strike prices and expiration date based on your opinion(s) (Option prices are as of market close May 15, 2009).

Strategy 1) Buy American Express (AXP) June 24 call & American Express June 24 put. To implement this strategy would cost roughly $420 and with financials trading +/- 10% on any given day American Express (AXP) above $28.20 or below $19.80 a share in 36 days doesn't seem impossible. AXP would have to change at least +/- 17.5% to profit from this strategy.

Strategy 2) Buy Bank of America June 11 call & Bank of America June 11 put. To use this strategy would cost roughly $259 and to break even BAC needs to be above $13.59 or below $8.41 a share at June option expiration. A change of +/- 23.5%.

Strategy 3) Buy Bank of NY Mellon (BK) June 27.50 call & Bank of NY Mellon June 27.50 put. To use this strategy would cost $430 per option contract, so BK would have to close above $31.80 or below $23.20. A change of +/- 15.6% by June seems feasible.

Strategy 4) Buy Citigroup (C) June 4 call & Citigroup June 4 put. This would cost roughly $128 to use and would pay off if Citigroup closed at or above $5.28 or below $2.72 a share (a more bullish person on C would want to straddle the $2.50 strike).

Strategy 5) Buy Goldman Sachs (GS) June 135 call & Goldman Sachs June 135 put. To open this position would cost roughly $1,500. GS would need to trade above $150 a share or below $120 a share to make money from this position at time of expiration.

Strategy 6) Buy JP Morgan (JPM) June 35 Call & JP Morgan June 35 put. To open this position would cost roughly $520 and in order to break even JPM would need to close at or above 40.20 a share or at or below 29.80 a share at the time of June expiration.

Strategy 7) Buy Morgan Stanley (MS) June 26 call & Morgan Stanley June 26 put. This would cost roughly $420 to use and would pay off if MS closed at or above $30.20 or below $21.80 a share (a more bearish person on MS would possibly want to straddle the $27 strike).

Strategy 8) Buy Wells Fargo (WFC) June 25 call & Wells Fargo June 25 put. To open this position would cost roughly $450. WFC would need to trade above $29.50 a share or below $20.50 a share to make money from this position at time of expiration.

Although I do not like trading leveraged ETF’s the here are two examples of opening a straddle position on the SKF (Ultrashort Financials) and FAS (Direxion 3X Financials).

Strategy 9) Buy SKF June 48 call & SKF June 48 put. This strategy would cost $1700 to open, and in order to profit from it the SDS would need to close +/- 35.4% the strike price by June expiration.

Strategy 10) Buy FAS June 9 call & FAS June 9 put. This strategy would cost $300 to open, and in order to profit from it the FAS would need to close +/- 33.3% the strike price by June expiration.

***USE CAUTION*** Please note that these straddle plays could be just as worthless as the paper they're written on, if any given stock doesn't move as much as needed it will surely lose money. The worst case scenario would be if the underlying asset closes on the expiration day exactly at the strike price- 100% would be lost. It is important to monitor a straddle position and I have found trading out of the position before expiration has been to my benefit.

To learn more more about trading options check out my option trading E-Book.


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