How Bollinger Bands Can Help You Win with Straddles

How you can use Bollinger Bands to help you find profitable options trading opportunities

Sep 4, 2015 at 9:50 AM
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    The key to a successful straddle is to locate a stock that's on the verge of making a drastic price swing either higher or lower. Since a straddle is composed of a long put and a long call at the same strike price, the direction of the move doesn't matter -- only its magnitude. Specifically, you need the shares to make a big enough move to offset the increased cost of buying double premium.

    Bollinger Bands are a technical indicator that can be crucial to your success in trading straddles. To create Bollinger Bands, you draw a line two standard deviations above and two standard deviations below a central moving average (typically, the 20-day).

    When these bands are spread wide apart, it indicates a period of rising volatility. On the other hand, when the bands are pinched close together, the stock is going through a period of contracting volatility. This latter scenario is where you need to start watching the shares carefully for a potential breakout. Once the contraction reaches an extreme level, oftentimes a phase of rapidly expanding volatility will follow.

    Most online investing and trading platforms allow you to plot Bollinger Bands on a stock's chart. When you're researching potential candidates for straddle plays, be sure you check out this indicator to find out where the stock has been and where it might be headed, from a volatility perspective.

    In the best-case scenario, you might find a situation where a stock's Bollinger Bands are at their narrowest status of the past year. This could be a big red flag that a major move is around the corner.

    As a final caveat, always be sure that you're keeping up with the latest company headlines. If there's a buyout offer on the table, the stock will generally remain in a low-volatility trading range very near the offer price. So, before you bet on a volatility explosion, be sure there's no other reason why the shares are range-bound.

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