Straddle Trade with Implied Volatility vs Historic Volatility

Straddle Trade with Implied Volatility vs Historic Volatility

CHART SET UP

STRADDLE SET UP USING HISTORIC AND IMPLIED VOLATILITY

CHART SET UP

• One year daily chart [ 1] • • 100 Bars empty space to the right side of chart for price / trend line projection . [ 2 ]

LOWER STUDIES

• Historic Volatility [ 3 ]

• Implied Volatility [ 4 ]

• Williams % R [ do not adjust use standard -80 , -20 ] [ 5 ]

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• • Average True range [ 6 ]

• { When using ATR in the set up formula to get a price range to work with for projection use MONTHLY TIME FRAME on ATR - since option contracts are monthly instruments ]

CRITERIA FOR OPTION STRADDLE CANDIDATE

A. EARNINGS DATE

Earnings announcement date MUST be AT LEAST 4 weeks in the future [ 1 ]

B. VOLATILITY [ 2 ]

Implied Volatility CAN NOT BE greater than .1 of one percent . ( 1/10 th of a percent . ) of Historic Volatility .

I.E Implied Volatility is .28 Historic Volatility is .26

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EXAMPLE : Historic Volatility is .26 + .10 = .36 Implied Volatility CAN NOT BE GREATER THAN .36 Any Implied Volatility BETWEEN or LESS THAN .36 is acceptable . A best case scenario is when the Implied Volatility is LESS THAN the HISTORIC Volatility .

C.WILLIAMS % R [ 3 ]

Williams % R must be OVER BOUGHT ( above minus 20 ). OVER SOLD (below minus 80 ) Or dead in the MIDDLE at minus 50 Williams % R study will / should DEFAULT to upper / over bought line of negative / minus 20 and a lower / over sold of negative / minus 80 .

D. PRICE MOVEMENT [ 4 ]

Last week or more there should be a Channeling movement either sideways , upward or dowanrd of the daily price range . I, E. a Channel

E. PRIOR EARNINGS PRICE MOVEMENT [ 5 ]

Look at price action prior to and after earnings announcement . The desired effect to look for on movement should be a large movement either UP or DOWN .

ENTERING THE TRADE

OPTION PRICE AND EXPIRATION DATE

A. OPTION EXPIRATION DATE must be AT LEAST 100 days or more into the future . [ 1 ]

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B. PURCHASE the options . DO NOT SELL. I.E. Buy to open Call Option and Buy to open Put Option . [ 2 ]

C. STRIKE PRICE of OPTION : Stock price should be as close to the strike as possible . [ 3 ]

EXAMPLE a : Stock is trading at 55.23 . Buy put and call options with a 55 Strike Price .

EXAMPLE b : Stock is trading at 48.00 Buy Call and Put Options with a 50 Strike Price .

CHARTING THE " BREAK EVEN TRIANGLE "

CHARTING THE " BREAK EVEN TRIANGLE "

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A. PLOTTING UPPER LINE OR " RAY " OF BREAK EVEN TRIANGLE Lines on the triangle show the amount of price action that the stock has to move by EXPERATION to break even on the cost of the Straddle.

FORMULA : Strike Price + Premium . { Premium is cost of the Straddle . Amount paid for Call Option + Amount Paid for Put Option .

I. E. Strike Price is 60 + $ 4.10 ( Call option ) + $ 4.10 ( Put Option ) = 68.20 68.20 = stock price for Point B of upper Ray .

a. From the present day on Daily 1 year chart . b . Find Strike Price on chart . [ Point A of upper Ray / Line ] ( 1 ) c. Find Expiration Date of Option . [ Point B of upper Ray / Line. ] ( 2 ) { This will be 100 days or more into the future . ] d. Draw a line from Point A to Point B . ( 3 ) [ This will be a parallel line at this point . From present day to Expiration date along the strike price. I. E . 60 ] e. At point B on the Ray raise it to the Strike Price + the Premium . ( 4 ) [ I.E. 60 + 8.20 = 68.20 ] f. End Product : You will have a Ray that goes UP from the Strike Price on the chart to theExpiration Date of the option .

B. PLOTTING LOWER LINE OR " RAY " OF BREAK EVEN TRIANGLE

. FORMULA : Strike Price - Premium . { Premium is cost of the Straddle . Amount paid for Call Option + Amount Paid for Put Option .

I. E. Strike Price is 60 - ( $ 4.10 ( Call option ) + $ 4.10 ( Put Option ) ) = 51.80 51.50 = Stock Price for Point B of Lower Ray

a. From the present day on Daily 1 year chart . b . Find Strike Price on chart . [ Point A of lower Ray / Line ] ( 1 ) c. Find Expiration Date of Option . [ Point B of lower Ray / Line. ] ( 2 ) { This will be 100 days or more into the future . ] ( 3 ) d. Draw a line from Point A to Point B . [ This will be a parallel line at this point . From present day to Expiration date along the strike price. I. E . 60 ] e. At point B on the Ray lower it to the : Strike Price - the Premium . ( 5 ) [ I.E. 60 - 8.20 = 51.80 ] f. End Product : You will have a Ray that goes DOWN from the Strike Price on the chart to the

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Expiration Date of the option .

YOU NOW HAVE YOUR " BREAK EVEN TRIANGLE "

NO FLY ZONE

DRAWING A RECTANGLE FOR A LOSS AREA

A.Use same chart that has " BREAK EVEN TRIANGLE " { the No Fly Zone will overlay partially on the triangle }

B. Starting at either POINT B on either Ray upper or lower { Where they end on the Expiration date } [ 1

C. Draw a rectangle to the OTHER POINT B on the other Ray . [ 2 ]

D. Now extend it BACK IN TIME to the announced Earnings Date PLUS 5 trading days. [ 3 ]

So the four corners will be :A. Upper left : Earnings Date PLUS 5 TRADING DAYS .B. Upper right : Point B on ascending Ray at expiration of option .

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C. Lower Left : Earnings Date PLUS 5 TRADING DAYS .D. Lower Right : Point B on Descending Ray at expiration of option .

You now have a No Fly Zone where you are at a loss on the trade .

AVERAGE TRUE RANGE CONFIRMATION

A . Average True Range . Set ATR study to a MONTHLY time frame . ( 1 ) If ATR is LESS THAN the Cost of the Stradle Price . I. E . Call Option $4.10 + Put Option $4.10 = $8.20 ( Price of Straddle )

I.E Monthlly Average True Range $5.99 ( 2 )

If ATR is GREATER THAN Cost of Straddle . This is a Bad Indication . Not necessarily a disqualification for entering a trade .

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If ATR is LESS THAN Straddle Price . This is a good indication for placing a trade. I.E ATR $5.99 is LESS THAN $8.20 Straddle Price This is a good sign to enter the trade

CLOSING THE TRADE

1. PROFIT STOP : 50% - Text Book recommendation . A. This is a judgement call . Example if you are in the trade for One week and have a profit of 20% this would also be a good Time to exit and take profits .

2. STOP LOSS : A. If not profitable after one week of earnings CLOSE OUT THE TRADE . B. DO NOT hold Option Straddle into the FRONT MONTH . C.No more than 25% loss of the price paid for the Straddle Option I.E. 25% Stop Loss .

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