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Spreads VS Selling Puts

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Market Trend: Still Up - But Watch For June

 

June 17 2011  / Research In Motion - Stock Symbol RIM (TSX) or RIMM (Nasdaq)

Long Straddle Strategy

Research In Motion

 

Long Straddle On RIM - An Explosive Option Trade

Today after the market closed an investor friend sent me his trade sheets for a long straddle strategy option trade he placed on Research In Motion (stock symbol RIM) on the Toronto Stock Exchange (TSX). This trade could have been duplicated on the NASDAQ where the symbol is RIMM.

My friend loves straddles and strangles. His preferred investing method is long straddles. He rarely does short strangles. He sent this straddle trade for me to put on the site to show how powerful options can and often are. He felt it may be of interest to other investors. He does only options on stocks that are making earnings announcements and is pretty picky about the stocks he selects. In a year he does perhaps two or three trades in a month. He had told me last Friday that he was doing a long straddle on RIM which would issue its earnings on Thursday June 16. He felt that because of all the bad news, the stock could fly either way.

Long Straddle Definition

A Long Straddle is a pretty simple trade. Almost always, call and put options at the same strike are purchased. The strike chosen is usually at the money. The strategy is that by holding puts and calls and going out a month or more, the investor will benefit from volatility in the stock. If the stock moves up or down wide enough, the straddle will be profitable. By going out at least a month or more, this affords time for the straddle to be profitable. As my friend indicates, straddles can be powerful and also not without risk. Time is not on the side of the straddle and the stock must move wide enough to make the straddle profitable.

Reasons For Using This Option Strategy

My friend enjoys the strategy as he only has a portion of his capital in the market at any given time and much of the time he does not have any capital in the market. He looks forward to volatility and finds this strategy excellent in bear markets and during periods of correction. In the past ten years we have had two severe bear markets and numerous corrections. This is why during market turmoil the long straddle is a decent option strategy to try. As well many stocks or industry sectors find themselves in bear markets even when the rest of the market is performing well. The concept is to look for a dozen or so opportunities in a year and capitalize on those. If the trade goes against the investor, close immediately. While many trades do not work out, as long as the failing trades are closed early, those that do work out can create a decent return. The most important aspect for many investors using straddle options is that much of their capital is never at risk in the market. The maximum amount that can be lost on any trade is known at the time the straddle is put in place.

The Research In Motion Long Straddle Example

On Friday June 10 2011, the stock closed at $35.82. Throughout the day the investor bought 30 puts and 30 calls at the July $34 strike.

Research In Motion chart - June 10 2011

Here are the costs associated with the long straddle. I have removed all the commissions from the trades as different investors will pay different commissions depending on the discount brokerage being used.

JUNE 10 2011 - Options Bought

25 Puts bought at July $34 strike - total amount invested - $4,125.00
25 Calls bought at July $34 strike - total amount invested - $8,875.00

Total capital at risk - $13,000.00

June 16 2011 - Earnings announced

JUNE 17 2011 - Options Sold
9:30 - 9:35 AM - 25 Calls July $34 strike sold - total amount earned - $400.00
11:00 - 11:15 AM - 15 Puts July $34 strike sold 
3:50 PM - 10 Puts July $34 strike sold - total amount earned - $17,700.00

Total income - $18100.00
Minus Capital invested - $13,000.00
TOTAL RETURN - $5100.00
Percent return - 39%

This type of trade is certainly not for everyone. If the quarterly results had been better the stock may have moved higher but not by enough to make the return worth the risk.

Additional Examples Of Long Straddles

Here are a couple of other long straddles. The first resulted in a loss and the second in a profit.

Here is my friend's MANULIFE FINANCIAL straddle trade - TSX Symbol MFC
This trade resulted in a loss

FEB 4 2011 - Bought Options

40 Puts bought at April $18 strike - total amount invested - $2,480.00
40 Calls bought at April $18 strike - total amount invested - $4,880.00

Total capital at risk - $7,360.00

Earnings Announced Feb 10 2011

FEB 11 2011 - Sold Options
40 Calls April $18 strike sold - total amount earned - $3080.00
40 Puts April $18 strike sold - total amount earned - $3640.00

Total income - $6720.00
Minus Capital invested - $7,360.00
TOTAL RETURN - loss of $640.00
Percent return - loss of 8.7%

Manulife Financial Stock Chart

Here is my friend's First Quantum Minerals straddle trade - TSX Symbol FM

April 29 2011 - Bought Options

10 Puts bought at June $135 strike - total amount invested - $9,700.00
10 Calls bought at June $135 strike - total amount invested - $9.850.00

Total capital at risk - $19,550.00

Earnings Announced May 9 2011

May 11 2011 - Sold Options
10 Puts June $135 strike sold - total amount earned - $17750.00
10 Calls June $135 strike sold - total amount earned - $4100.00

Total income - $21,850.00
Minus Capital invested - $19,550.00
TOTAL RETURN - $2300.00
Percent return - 11.76%

First Quantum Minerals Straddle Option

 

SUMMARY

Like all option strategies, this one has risks associated with it. However the one advantage is not having capital at risk all the time in the market. These are short term trades which helps to limit risk of the capital involved. Not every long straddle is short term. Some investors do 6 month out or even leap straddles. For my friend though, the shorter the better and he prefers to put in place the straddle just before earnings announcements. While this is not a strategy I use, I can definitely see the advantages of implementing it.. 

 

Disclaimer: There are considerable risks involved in all investment strategies. Trade at your own risk.
Stocks, options and investing are risky and can result in considerable losses. None of the strategies, stocks or information discussed or presented are financial advice, trading advice or recommendations. Fullyinformed.com is a private website. Everything presented and discussed are the author's ideas and opinions only.
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