More Uncertainty Ahead... Profit from Volatility with Option Straddles

Although the market is a bit more stable today than in previous months, according to the VIX (volatility index) which is down over 50% from its 52 week high set in October, it is still at historic highs. With volatility at these levels there is no doubt it is still a trader's market. Below is a weekly chart of the VIX. As you can see every time the VIX went above 30 it never stayed above 30 too long, until the most recent time (September 2008) we have been above 30 ever since (it has traded below 30 intraday but never closed at or below 30).



One way I have been able to profit from the volatility over the past 7 months is by using the option straddle strategy. 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 straddle a stock I like to go 30-40 days out until expiration.

Below are some option straddle strategies I’ve used, or am currently using. You'll need to adjust strike price and expiration date based on your opinion(s) (Option prices are as of market close May 13, 2009).

Strategy 1) Buy Apple June 120 call & Apple June 120 put. This strategy would cost roughly $1,300 and in order to make money Apple (AAPL) needs to be above $133 or below $107 a share come June expiration. A change of +/- 11%.

Strategy 2) Buy Google June 390 call & Google June 390 put. To use this strategy would cost roughly $3,500 and break even is Google (GOOG) above $425 or below$355 a share at June option expiration. A change of +/- 9%.

Strategy 3) Buy Ford June 5 call & Ford June 5 put. To use this strategy would cost $130 per option contract, but given the current state of the auto industry Ford (F)+/- 26% by June seems feasible.

Strategy 4) Buy Research in Motion June 70 call & Research in Motion June 70 put. This would cost roughly $1,200 to use and would pay off if Research in Motion (RIMM) closed at June expiration above $82 or below $58 a share. A change of +/-18%.

Strategy 4) Buy American Express June 24 call & American Express June 24 put. To implement this strategy would cost roughly $460 and with financials trading +/- 10% on any given day American Express (AXP) above $28.60 or below $19.40 a share in 38 days doesn't seem impossible. AXP would have to change at least +/- 20% to profit from this strategy. Similar strategies could also be used with many other volatile financial stocks or ETF’s.

Strategy 5) Buy First Solar June 175 call & First Solar June 175 put. To open this position would cost roughly $3,000. First Solar (FSLR) would need to trade above $205 a share or below $145 a share to make money from this position at time of expiration. A change of +/-18%.

Strategy 6) Although I do not like trading leveraged ETF’s here is an example of opening a straddle position on the SDS (Ultrashort S&P 500). Buy SDS June 61 call & SDS June 61 put. This strategy would cost $970 to open, and in order to profit from it the SDS would need to change +/- 16% 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.


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