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Guy Halpin Options are a versatile derivative with dozens of strategies on offer. My favorite strategy is the strangle. A strangle involves buying a slightly OTM put and call. This strategy makes money when there is moderate to large movement in the stock’s price either up or down.
When a stock forms a consolidation triangle (pennant) it is an indication that there is a breakout pending. Figure 1 below shows a recent consolidation triangle for eBay.
Figure 1 – eBay Bar Chart
click chart for more detailOn the 28th of October a strangle on eBay could have been entered by purchasing a 37.50 put and 40 call for a debit of $410. Up until the time of writing, eBay has rallied to close at $42.30, which is a resistance level. If eBay is to close above $42 in two consecutive trading days, the next expected level of resistance is $45. If eBay hits $45 a 50% profit will be achieved. Should the current resistance level hold, this trade will hit the profit target to the bearish side with a price of $31.50.
For traders familiar with option risk graphs, figure 2 below was produced using OptionGear on the 9th of November. This risk graph shows the profit/loss on the horizontal axis and stock price on the vertical axis. If eBay closes above $43.25 or below $33.85 in the next 41 days (73 – 32) this trade will be profitable.
Figure 2 – Strangle Risk Graph
click chart for more detailAs with any strategy it is imperative to have a trading plan clearly detailed. As mentioned above my profit stop is 50%, which would be achieved when the position is worth $6.15 (or a profit of $205) and a time stop of 32 days before expiration which, as a worse case scenario, would render a loss of just under $200.
Happy trading!
Guy Halpin
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