Straddles and Strangles Bought Strangle Technical Analysis – Technical Pattern

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As a stock consolidates it becomes less volatile so the premiums will become cheap. In this period money can be made if the stock breaks out in the assumed time frame. The most common technical formations that indicate a strong move is close are the pennants, flags and triangles. When investing into certain technical patterns such as pennants, flags and descending triangles (draw a line from the tops and the bottoms with the point on the right hand side of the graph), as demonstrated below.

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Bought Strangle Psychology

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There is a time and a place for bought straddles and strangles. Ideal market conditions are when volatility is low and expected to increase. The bought strangle is a non-directional trade with the share price able to move upwards or downwards to profit in this strategy.

The idea with bought strangles is to identify a large share price move. This share price move can be either an increase or decrease in share price. To identify these moves you can look at technical analysis and fundamental analysis. Technical analysis tried to identify a break out pattern, while the fundamental analysis indentifies a particular announcement that may cause a large move in share price.


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The Bought Strangle Strategy

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The bought strangle, is a volatile option trading strategy that profits when the stock goes up or down strongly. The Strangle is a similar to the bought straddle. The strangle is in essence a technique used to place a straddle at a cheaper price. The strangle requires a lower debit amount to put on and works exactly like a straddle. One should use a strangle when one is confident of a move in the underlying asset but is uncertain as to which direction it may be. These uncertain moves can be identified through both fundamental and technical analysis.

Establishing a strangle simply involves the simultaneous purchase of an out-of-the-money call option and an out-of-the-money put option on the underlying asset. An out-of-the-money call option allows you unlimited profit to upside when the stock moves higher than the strike price with limited loss to down side. An out-of-the-money put option allows you unlimited profit to downside when the underlying stock moves lower than the strike price with limited loss to upside. Combine them both and you will have a strangle which profits when the underlying stock moves up or down beyond the strike price of the respective options. As the out-of-the-money options in a strangle is cheaper than the at-the-money options in a straddle, a strangle is sometimes described as a “cheap straddle”.

Author: Matthew Gartrell

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BHP Bear Call Spread Example

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BHP Bear Call Spread

Trade

Sell 5 BHP Feb 09 3200 Calls @ 96

Buy 5 BHP Feb 09 3300 Calls @ 68

Net Credit = 28 cents

This trade requires margin requirements.

Maximum Profit

The ideal result is for the share price to stay below the lower strike price of $32.00.

Max Profit = Net premium received

= 96 -68

= 0.28 x 5 contracts

= $1400

Maximum Loss

This will occur if the share price is above the bought call option at expiry

Max Loss = Total spread less Net Premium Paid

= 0.72 * 5 contracts

= $3,600

Breakeven

Lower strike plus net premium received

Breakeven = 32.00 + 0.28

= $32.28

Risk vs. Reward

Risk 28 cents to make 72 cents profit.

Risk vs. Reward = 1: 0.3889

Main Benefits of Strategy

  1. Provides leveraged exposure to a fall in the share price
  2. Takes advantage of time decay
  3. The ideal result is for the options to expire worthless, which means the client will save on brokerage not having to close the position to take a profit.

Technical Analysis

  • Downtrend
  • Trade is above resistance
  • Share Price is below short-term moving averages


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Bear Call Spread: Technical and Fundamental Analysis

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Technical Analysis

Identifying bear call spreads can be assisted through technical analysis. Technical analysis allows identification of expected price movement through indentifying trends through momentum indicators and trend lines. The types of chart patterns you are looking to identify a bear call trade are:

  • Strong resistance levels
  • Down trends
  • Trading ranges

Fundamental Analysis

Fundamental analysis can determine if a trade is viable or not. There are a number of fundamental factors that influence the option prices of a stock. When identifying a bear call spread you have a bearish outlook on the share. Therefore you are looking for negative news in the company or sector. As this trade also makes money if the share price does not move it if there is no news coming out of the company for the next month this can also be a positive for this particular strategy.


To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bear Put Spread: Woolworths Limited (WOW) Past Recommendation

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This is a past recommendation that demonstrates how a bear put spread is implemented in real life.

Trade:

Bear Put Spread

Sell 2 WOWB7 Sep 08 2200 Puts @ 55

Buy 2 WOWW3 Sep 08 2550 Puts @ 175

Net Cost = 120 cents

This trade requires no margin requirements.

Maximum Profit

The ideal result is for the share price to fall below the lower strike price of $22.00.

= Difference between strike prices less net premium received

= 3.50 – 1.20

= 2.30 x 2 contracts

= $4,600

Maximum Loss

This will occur if the share price is above the bought at expiry

= Net Premium Paid

= 1.20 * 2 contracts

= $2,400

Breakeven

Higher strike minus net premium received

= 25.50 – 1.20

= $24.30

Main Benefits of Strategy

1. Provides leveraged exposure to a decrease in the share price

2. The ideal result is for the share price to fall below the lower strike price of $22.00.

Risk:

The main risk is for the share price to increase above profitable range ($25.50) and stay there until expiry. If the position expires above the high strike, the position will expire worthless and there will be no exit cost to the trade. If it is below, we will have to exit the trade to avoid being exercised. A change in volatility levels can also have an effect on the profitability before expiry, however the max loss and profit is known at expiry. Contact your adviser for more information.

Technical Analysis

WOW has a large bearish head and shoulders pattern which has taken about a year and a half to develop. These patterns are usually very reliable and the stock has broken below the neck line this morning. The head and shoulders give a price target of $17.00. We are trading a bear put spread out to September which will return around 200% if the stock falls to $22.00 which is realistic considering the price target for this pattern is $17.00. The September position gives just over 3 months for the stock to fall. Due to the break today, the volatility on the out of the money puts options are very high, so this trade is actually been filled for below fair value which of course is in our favour.


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Bear Put Spread: Technical and Fundamental Analysis

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Technical Analysis

Identifying bear put spreads can be assisted through technical analysis. Technical analysis allows identification of expected price movement through indentifying trends through momentum indicators and trend lines. Technical indicators used to identify bear put spreads include:

  • Share Price Downtrend
  • Overbought – MACD and Stochastic
  • Momentum indicators
  • Breaks below support

Fundamental Analysis

Fundamental analysis can determine if a trade is viable or not. There are a number of fundamental factors that influence the option prices of a stock. When identifying a bear put spread you have a bearish outlook on the share. Therefore you are looking for negative news in the company or sector. This may be a worst then expected profit announcement or a global affect on a specific sector or industry.


To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bull Call Spread: Past Recommendation

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Below is a past recommendation on Oxiana which is now known as Oz Minerals (OZL). This Bull Call Spread demonstrates how the strategy works in real life.

OXR Bull Call Spread

Trade:

Bull Call Spread

Buy 12 OXR Feb 325 Calls @ 17

Sell 12 OXR Feb 350 Calls @ 9

Net Debit = 8 cents

This trade requires no margin requirements.

Maximum Profit

The ideal result is for both the share price to be above $3.50 at 28th February.

= Spread minus cost

= 0.25-0.08

= 0.17

On 12 contracts this is a return of $2040, which is 212.5% return.

Maximum Loss

This is the cost of placing the trade which is $0.08 which on 12 contracts is $960.

Breakeven

The breaks even at expiry is $3.25+$0.08 = $3.33.

Risk vs. Reward

Risk = 8 cents Reward = 17 cents

Risk vs. Reward = 1:2.125

Fundamental View

The fundamental analysis below outlines that OXR at the time of the recommendation was sound fundamentally.

OXR’s diversified asset base provides excellent exposure to buoyant copper, zinc and gold prices. The company’s medium and long-term production profile is very strong, with the Prominent Hill copper/gold project in South Australia, the Sepon Copper expansion in Laos and the Matarbe gold project in Indonesia expected to translate to significant production growth in 2009 and beyond. An expansion at Golden Grove in Western Australia is also likely to occur that should translate to a significant extension of that project’s operational life. (Source StoneBridge Research)

Technical Analysis

The below is the analysis on the OXR chart when this recommendation was made.

OXR is oversold and today the share price looks to be heading back up towards resistance at $3.60. The momentum indicators are crossing over indicating a buy signal. This means OXR has been oversold and the current share price increase indicates a change in trend. Below is a chart of Oxiana.

Chart


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Bull Call Spread: Technical and Fundamental Analysis

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Technical Analysis

Identifying bull call spreads can be assisted through technical analysis. Technical analysis allows identification of expected price movement through indentifying trends through momentum indicators and trend lines. Indicators which are used when identifying trade opportunities to enter a bull call spread are:

  • Share Price Uptrend
  • Oversold – MACD and Stochastic
  • Momentum indicators
  • Break out formations

Fundamental Analysis

Fundamental analysis can determine if a trade is viable or not. There are a number of fundamental factors that influence the option prices of a stock. When identifying a bull call spread you have a bullish outlook on the share. Therefore you are looking for a positive announcement either for the share, sector or share market in general.


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Selection Criteria – Buying Options

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When buying call options and put options it is critical to have good timing. When buying call options you don’t only need the stock to increase in value you need it to do so before the time decay in the option starts to affect the option value. Selecting the entry point (timing) of the trade can be assisted through technical and fundamental analysis. You can use technical analysis to identify break-out patterns to trade through buying calls or puts. It is important to make sure you buy enough time for expected movements. Also to make sure you buy your option at a reasonable price, you must analyse the volatility and make sure you are buying when volatility is low and expected to increase. Always make sure the option has enough open interest so liquidity is not an issue. If you stick to the blue chips this should not be an issue. Buying out-of-the-money calls is higher risk but potentially has large percentage returns. However, buying at-the-money calls has a higher delta but costs more so percentage returns are smaller.


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