The Strangle – Illustrated with Campbell Soup

There are many different strategies that I use with options and over the next few weeks I will continue to go through some of them to help explain the strategy and how it can be used to access the market with controlled risk. Today’s is the Strangle (links to the rest of the series are below).

Strangle

This strategy consists of buying one Put Option and one Call Option on either side of the stock price to create a Strangle hold around the stock. If you use the same strike price for the Put and Call it is called a Straddle. This trade is entered for one of 3 reasons. When there is no clear conviction on direction of a large expected move, a view that the stock will not move much or when Implied Volatility is abnormally high or low. The Strikes are chosen to maximize the potential gain depending on which circumstance. If the trade is to be able to win on a move in either direction then the strikes will be tight and it might possibly be a Straddle. The trader will buy this combination or be long the Strangle or Straddle. The trader will sell the option that is against the ultimate move to recapture some premium and hold the option in the direction of the move until their target. If the trade is for a limited move then the strikes will be further apart to protect against the move and the trader will sell the Strangle pocketing the premium. Here the trader is looking for both sold options to expire worthless. The maximum gain on the sold Strangle is the premium taken in. If the trade is for a drop in volatility then the trader will sell the Strangle before an event looking to either buy it back at a lower price or to buy one of the pieces. Confusing? Lets look at an example from a trade we took recently on Campbell Soup, $CPB.


Campbell Soup had been building a Diamond pattern. There was support lower at 32.75 and then 31.75 and resistance higher at 34 followed by 34.50 and 34.75. The Relative Strength Index was moving sideways in bullish territory just over the mid line and the MACD was stable in bearish territory. This could be either a topping pattern or a continuation pattern. And gives rise to the trade idea. The target on a breakout either way is a move of $3.75. The options board shows that the implied volatility is very low at under 23% but slightly elevated compared to the historical at 17%. This is a decent candidate to buy the volatility.

Trade Idea: Buy the December 33/34 Strangle

Buying both the December 34 Call and the December 33 Put to create the Strangle cost $1, and that is your worst case downside risk. This makes a profit on a move below 32 or above 35 or 4.5% from where it was trading at 33.50. On a sharp move the option that had exposure in the opposite direction should be sold quickly to capture any value and the one in the direction of the move sold on a stall or bounce or a profit target (29.75 or 37.25).

The stock did break lower and I sold the 34 Calls quickly but only for 10 cents, later selling 1/3 of the 33 Puts for 1.25 and another 1/3 later in the day at 1.50. I will keep the last 1/3 for a continued move lower.

The Ratio Put Spread – Illustrated with Salesforce.com

The Put Butterfly – Illustrated with Nordstrom

The Call Spread Risk Reversal – Illustrated with Leap Wireless

For more details on how I traded this name and for more ideas and deeper analysis, use the Get Premium button above. As always you can see details of individual charts and more on my StockTwits feed and on chartly.

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The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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