How to Profit From Market Volatility with Options Strategies

A straddle is a great way to profit from volatility spikes

Feb 10, 2016 at 3:51 PM
facebook twitter linkedin

When learning about options strategies, traders almost always familiarize themselves with directional plays first. Think a stock will move higher? Buy a call. Think it will move lower? Buy a put. But what about profiting from volatility? This is where the long straddle comes in.

Unlike long calls and puts, the straddle is directionally neutral -- that is, a trader won't necessarily have a firm sense of where the underlying stock is headed. Instead, what he's banking on is a sharp move in one direction or the other. To initiate the straddle, the trader will buy to open a call option and a put option at the same at-the-money (ATM) strike.

For instance, Goldman Sachs just recommended buying a straddle on Priceline Group Inc (NASDAQ:PCLN) ahead of next Wednesday morning's earnings report, citing "underpriced" options. With the shares at $1,037.73, for example, a trader could purchase one February 1,040 call at an ask price of $54.20 and a February 1,040 put at an ask of $56.40. In this case, the initial cash outlay would be just over $11,000 ($110.60 premium paid * one contract * 100 shares per contract).

By doing so, the trader has set himself up to profit if PCLN topples the upper breakeven of $1,150.60 (strike plus premium paid) or breaches the lower breakeven of $929.40 (strike less premium paid) by next Friday's close, when the front-month options expire. That's a roughly 10% move in either direction.

Diving deeper, however, it appears premium on PCLN's near-term options is actually quite elevated at this point. The stock's Schaeffer's Volatility Index (SVI) sits at an annual high of 78%, while its 30-day at-the-money implied volatility of 56.7% ranks in the top percentile of its 52-week range. In other words, the options market is pricing in more short-term volatility than usual, suggesting bargain hunters may want to look elsewhere. To put this in perspective, following its last eight earnings reports, Priceline Group Inc has averaged a single-day move of just 5.3% -- approximately half of what the straddle requires to hit breakeven.

By contrast, consider a stock like J C Penney Company Inc (NYSE:JCP), which has an SVI of 56% -- in the low 30th percentile of its annual range. In other words, the stock's short-term options are relatively inexpensive, from a volatility perspective.

With the shares at $7.52, a speculator could initiate a straddle by buying one ATM February 7.50 call for $0.26 and a February 7.50 put for $0.25, for an initial cash outlay of $51 ($0.51 premium paid * one contract * 100 shares per contract). To profit, the trader would need JCP to make a roughly 7% move in either direction -- to take out the upper and lower breakeven marks of $8.03 and $7.01, respectively -- before next Friday's closing bell.

Minimize Risk While Maximizing Profits

There is no options strategy like this one, which consistently minimizes risk while maintaining maximum profits. Perfect for traders looking for ways to control risk, reduce losses, and increase the likelihood of success when trading calls and puts. The Schaeffer’s team has over 41 years of options trading success targeting +100% gains on every trade. Rest assured your losses are effectively limited to your initial cost at the time of making your move! Don't waste another second... join us right now before the next trade is released! 



Special Offers from Schaeffer's Trading Partners