June 17
2011 / Research In Motion - Stock Symbol RIM (TSX)
or RIMM (Nasdaq)
Long Straddle Strategy
Research In Motion
Long Straddle
On RIM - An Explosive Option Trade
Today after the market closed an investor friend
sent me his trade sheets for a long straddle
strategy option trade he placed
on Research In Motion (stock symbol RIM) on the
Toronto Stock Exchange (TSX). This trade could
have been duplicated on the NASDAQ where the
symbol is RIMM.
My
friend loves straddles and strangles. His
preferred investing method is long straddles. He
rarely does short strangles. He
sent this straddle trade for me to put on the
site to show how powerful options can and often
are. He felt it may be of interest to other
investors. He does only options on stocks that
are making earnings announcements and is pretty
picky about the stocks he selects. In a year he
does perhaps two or three trades in a month. He
had told me last Friday that he was doing a long
straddle on RIM which would issue its earnings
on Thursday June 16. He felt that because of all
the bad news, the stock could fly either way.
Long Straddle Definition
A Long Straddle is a pretty simple trade.
Almost always, call and put options at the same strike are
purchased. The strike chosen is usually at the money. The
strategy is that by holding puts and calls and going out a
month or more, the investor will benefit from volatility in
the stock. If the stock moves up or down wide enough, the
straddle will be profitable. By going out at least a month
or more, this affords time for the straddle to be
profitable. As my friend indicates, straddles can be
powerful and also not without risk. Time is not on the side
of the straddle and the stock must move wide enough to make
the straddle profitable.
Reasons For Using This
Option Strategy
My friend enjoys the strategy as he only has a portion of
his capital in the market at any given time and much of the
time he does not have any capital in the market. He looks
forward to volatility and finds this strategy excellent in
bear markets and during periods of correction. In the past
ten years we have had two severe bear markets and numerous
corrections. This is why during market turmoil the long straddle
is a decent option strategy to try. As well many stocks or
industry sectors find themselves in bear markets even when
the rest of the market is performing well. The concept is to
look for a dozen or so opportunities in a year and
capitalize on those. If the trade goes against the investor,
close immediately. While many trades do not work out, as
long as the failing trades are closed early, those that do
work out can create a decent return. The most important
aspect for many investors using straddle options is that
much of their capital is never at risk in the market. The
maximum amount that can be lost on any trade is known at the
time the straddle is put in place.
The Research In Motion Long Straddle Example
On Friday June 10 2011, the stock closed at $35.82.
Throughout the day the investor bought 30 puts and 30 calls at the
July $34 strike.
Here are the costs associated with the long straddle. I
have removed all the commissions from the trades as
different investors will pay different commissions depending
on the discount brokerage being used.
JUNE 10 2011 - Options Bought
25 Puts bought at July $34 strike - total amount invested
- $4,125.00
25 Calls bought at July $34 strike - total amount invested -
$8,875.00
Total capital at risk - $13,000.00
June 16 2011 - Earnings announced
JUNE 17 2011 - Options Sold
9:30 - 9:35 AM - 25 Calls July $34 strike sold - total
amount earned - $400.00
11:00 - 11:15 AM - 15 Puts July $34 strike sold
3:50 PM - 10 Puts July $34 strike sold - total amount earned
- $17,700.00
Total income - $18100.00
Minus Capital invested - $13,000.00
TOTAL RETURN - $5100.00
Percent return - 39%
This type of trade is certainly not for everyone. If the
quarterly results had been better the stock may have moved
higher but not by enough to make the return worth the risk.
Additional Examples Of Long Straddles
Here are a couple of other long straddles. The first
resulted in a loss and the second in a profit.
Here is my friend's MANULIFE FINANCIAL straddle trade -
TSX Symbol MFC
This trade resulted in a loss
FEB 4 2011 - Bought Options
40 Puts bought at April $18 strike - total amount invested
- $2,480.00
40 Calls bought at April $18 strike - total amount invested
- $4,880.00
Total capital at risk - $7,360.00
Earnings Announced Feb 10 2011
FEB 11 2011 - Sold Options
40 Calls April $18 strike sold - total amount earned -
$3080.00
40 Puts April $18 strike sold - total amount earned -
$3640.00
Total income - $6720.00
Minus Capital invested - $7,360.00
TOTAL RETURN - loss of $640.00
Percent return - loss of 8.7%
Here is my friend's First Quantum Minerals
straddle trade - TSX Symbol FM
April 29 2011 - Bought Options
10 Puts bought at June $135 strike - total amount invested
- $9,700.00
10 Calls bought at June $135 strike - total amount invested
- $9.850.00
Total capital at risk - $19,550.00
Earnings Announced May 9 2011
May 11 2011 - Sold Options
10 Puts June $135 strike sold - total amount earned -
$17750.00
10 Calls June $135 strike sold - total amount earned -
$4100.00
Total income - $21,850.00
Minus Capital invested - $19,550.00
TOTAL RETURN - $2300.00
Percent return - 11.76%
SUMMARY
Like all option strategies, this one has risks associated
with it. However the one advantage is not having capital at
risk all the time in the market. These are short term trades
which helps to limit risk of the capital involved. Not every
long straddle is short term. Some investors do 6 month out
or even leap straddles. For my friend though, the shorter
the better and he prefers to put in place the straddle just
before earnings announcements. While this is not a strategy
I use, I can definitely see the advantages of implementing
it..
