Straddle or Strangle...Witch Is It?

 

'Tis the season to do a little strangling.  In this case our "victim" will be none other than Whole Foods Market (WFM) just because I'm a little hungry....for a few frog legs!  Kidding.  Just keeping those colorful little critters guessing as the "frightful night" approaches.

 

 

Using a strangle options strategy is often just another "lose your money in a fancy way" suckers bet. 

 

 Strangling is an options strategy where the investor holds a position in both a call and put with different strike prices but with the same maturity and underlying asset.  An example of this using a stock priced at $50 is as follows. In order to strangle that $50 underlying stock price you might buy a call at the $45 strike price and buy a put at the $55 strike price.  Buying a call means that you think the price of the stock may rise.  Buying a put mean you may think that the price of the stock is going to fall.

The current price of WFM is at $64.  Hmmm.  Because its dead on the whole dollar (64) looks like I will have use the strangle's evil twin...the straddle.  A straddle is an options strategy with which the investor holds a position in both a call and put with the same strike price and expiration date.  So in this case I will simply buy a November $64 call and a November $64 put.  Shoot, my Halloween theme just shot out of here like a bat out of the batcave.  Wait just a second...I guess I will get to use my Attack of the 50 Ft.Woman poster one more time!

A 50 foot tall women should never straddle a highway on-ramp.  You might as well text and drive instead.  (Oh, why didn't I buy the model with the sunroof?!?...moon roof?)

By buying the 64 strike call and a 64 strike put for .47 and .45 respectively everything is fairly "even Steven".  Remember that .47 for example is multiplied by 100 because there are 100 share for each option contract.  So one call option will cost $47 and one put option will cost $45.

 

Dude looks like a Tyler, no?

 

                                                         Dude looks like a Munch, no?

 

But what would make a monkey want to straddle a Whole Foods Market? 

  The answer is two fold.  First and as per usual I am utilizing a pre-earnings strategy.  Earnings for WFM is November the 6th right after the close.  This strategy is all about the volatility, and the anticipation of a good or bad earnings result can make both calls and puts rise.  This is referred to as the volatility rush, and the plan is to buy a few days before the earning announcement and sell prior to that announcement.  If you don't sell prior to the announcement you may be turning a fairly low risk strategy into a high risk lesson in volatility crush as option prices can deflate immediately after the announcement; another example of "buy the rumor sell the news".

If you are new to options, but observant, you might ask, "why just buy a few days before the earnings announcement, why not buy a few weeks before the announcement."  The simple answer is that options decay like that new car you just drove off the lot.  The right balance between time decay and volatility is key to making $$ using this strategy.

 

View of decaying call or put option.

 

 

...and under magnification.

 

Just because a stock has an earnings announcement upcoming doesn't necessarily make it a good candidate for a pre-earnings straddle though.  An implied volatility history that looks like an electrocardiogram of a healthy, blood red, beating heart is what you may want to look for.

 

Notice the rise of the pre-earnings rush and the fall of the post earning crush?  Keeping your eye on implied volatility (IV) will at least give you a logical reason to enter a trade with a particular stock.

 

 

Let's put this trade in the pumpkin patch for a few days and hope for a Hallowinner.

 

 

 

Postscript 10/31: After all that,  I looked at the wrong options chain so the actual strike prices are incorrect.  Looks like this one is more a trick than a treat.  Maybe a do over next month?