Long Straddle Can Profit From Volatility in CRM

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Salesforce (CRM) stock has traded between 220 and 230 for the best part of a month with Bollinger Bands that are as tight as we’ve seen in the last 6 months.




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A lot of times when a stock goes through a period of price compression like this, it then experiences a breakout. That could be a bullish breakout or a bearish breakout, but as options traders we can set up a trade that will profit regardless of which way the stock breaks out — as long as it breaks out.

The strategy is called a long straddle and it is constructed through buying an at-the-money call and an-at-the-money put.

Buying at-the-money options can be expensive, and they will suffer from time decay, meaning that they will lose a little bit of value with each day that passes if the stock doesn’t make a big move.

With a long straddle, the further out in time the trade is placed, the slower the time decay, but the options are more expensive and require more capital.

For long straddles, I usually go out about three to four months and then look to close the trade halfway through if the profit target or stop loss have not yet been hit. This helps to minimize the time decay, which gets more severe the closer the trade gets to expiration.

For CRM stock, a long straddle could be placed by buying a May 21 220 strike call and put. The call was trading yesterday around $20.75 and the put around $18.40.

When we add the two together, the total cost of the trade would be around $39.15 per contract or a total of $3,915.

This is the amount of risk in the trade and the maximum that could be lost.

Long Option Straddles Can Profit From Big Moves Up Or Down

The break-even prices are calculated by taking the strike price plus and minus the cost of the straddle. That gives us break-even prices of 180.85 and 259.15, but profits can be made with a smaller move if the move comes earlier in the trade.

For example, the estimated break-even prices at the end of December are 194 and 237.

Changes to implied volatility will have a big impact on this trade and the interim break-even prices, so it’s important to have a solid understanding of volatility before placing a trade like this. Salesforce’s implied volatility is currently 32% which is toward the lower end of the 12-month range.

The worst-case scenario with this CRM long straddle would be a stable stock price which would see the call and put slowly lose value each day. For a long straddle I usually set a stop loss at around 20% of capital at risk which would be around $780.

One thing to keep in mind with this trade is the earnings date for CRM stock which will occur in the last few days of January. Once the earnings numbers have been released, these options could drop in value because the uncertainty surrounding the earnings release is removed.

It’s important to remember that options are risky and investors can lose 100% of their investment.

This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.

Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ

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