From the October 01, 2012 issue of Futures Magazine • Subscribe!

Using straddles and strangles to trade a “too close to call” election

Options Strategy

As of Sept. 5, the SPDR ETF (SPY) is trading at $140.98. The September 141 calls have an implied volatility of 13.6, the October 141 calls of 14.8 and the November 141 calls of 16.3. The CBOE Volatility Index (VIX) futures for September, October and November are 18.50, 20.00 and 22.35 with the VIX at 17.60. The VIX derives its price from the time value that is embedded in SPX options. The VIX is at an abnormally low level to begin with, but the election is influencing the pricing of the November options heavily as well. 

Purchasing the SPY November 141 Straddle at $8.40 would give a trader an upside breakeven point of $149.40 and a downside breakeven point of $132.60. The SPY had a low of $129.07 and a high of $142.18 over the previous 10 weeks. While election results alone could make that straddle a winner, there are ways for a trader to narrow the size of the breakout necessary for this strategy to be profitable. 

The SPY October 137 puts are at $2.00 bid while the October 145 calls are $0.94 bid. If SPY remains between 137 and 145, the SPY strangle would expire worthless and the new cost basis of the trade would be $5.46 with 25 days left until expiration. At this time traders can choose to sell additional options against their straddle or let it ride. The ideal price points at October expiration would be either 145 or 137. If SPY blows past 137 or 145, the loss would be limited to $1.46 (see “A profitable platform”).

Although November implied volatility is much higher than that of the preceding months, it still is relatively low. Going long November volatility while shorting the nearer-term volatility could be the way to go.

Dan Keegan is an instructor with the Chicago School of Trading. Reach him at dan@thechicagoschooloftrading.com.

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