Over the last few months, I've been looking at the use of options strangles to make a non-directional play on a stock around a major event, particularly earnings reports. Recently, I suggested this strategy to bored Apple (NASDAQ:AAPL) investors as they twiddle their thumbs through the peaks and valleys on the way to $600.
Typically, traders and investors use strangles to profit from the sharp move, one way or the other, volatile stocks tend to take post-earnings release. As I personally experienced with Amazon.com (NASDAQ:AMZN) earlier this year and illustrated with AAPL in the above-linked article, you can sometimes realize gains on both ends of a strangle the week prior to earnings.
The more I watch stocks that consistently trade with wide intraday ranges, the more attractive the strangle becomes as a regular, non-event driven trade on the right stock. For experienced investors, a daily or weekly strangle could represent a way to generate profit as a stock like AAPL, for example, frustrates by flirting with key psychological levels only to pull back. Think of it as an exciting alternative to the relatively conservative covered call.
For a strangle to work successfully, you need a volatile move in a stock in a short period of time, usually over the span of one or two trading days. If you look at the historical daily prices of AAPL throughout 2011, you'll find that more often than not it trades in a wide enough range to profit from a strangle, even without the use of very sophisticated methods to time entry and exit out of each side of the trade.
In fact, looking at the first 145 trading days of 2011 (through Friday, July 29th), AAPL's intraday range (the difference between its low and high of the day) was $5.00 or greater 82 times. AAPL's range was between $3.00 and $4.99 54 times and its range was less than $3.00 just nine times.
I do not feel comfortable anointing this strategy on the basis of the historical stock price data alone. I want to be able to assess how the options I would have used to strangle the stock acted on each day. Unfortunately I do not have access to historical option premium data. That said, I think there's something here. And it makes sense to collect richer data over the next several weeks and months to confirm what I think the incomplete data from the past tells me.
Going forward, I intend to collect a sample that includes historical stock and option prices to assess the efficacy of this strategy. In this article, I scratch the surface, looking at how AAPL traded on Wednesday, July 27th, Thursday, July 28th and Friday, July 29th. Using these three days, in addition to what I have witnessed, but not recorded, over the last year, day in and day out, leads me to believe merit exists in strangling AAPL on a regular basis. This, of course, assumes it continues to trade with similar patterns.
If the July 27th, 28th and 29th action in AAPL is any indication, my strategy holds promise. Here are the key statistics in the stock and the strangle I would have likely executed (buy both the August $395 call and $405 put) from Wednesday:
Stock. Open- $400.59. Low- $392.15. High- $402.64. Close- $392.59.
$395 call. Low- $9.45. High- $14.23. Close- $9.80.
$405 put. Low- $11.05. High- $18.20. Close- $17.85.
And here's the chart from that day, courtesy of FreeStockCharts.com:
Click to enlarge
And on Thursday, I would have pulled off the August $390 call/$395 put strangle:
Stock. Open- $391.62. Low- $388.13. High- $396.99. Close- $391.82.
$390 call. Low- $9.70. High- $14.14. Close- $11.10.
$395 put. Low- $9.25. High- $14.27. Close- $11.40.
And here's the chart from that day:
Click to enlarge
On Friday, I would have chosen the August $385 call/$390 put strangle:
Stock. Open- $387.64. Low- $384.00. High- $395.15. Close- $390.48.
$385 call. Low- $11.07. High- $16.15. Close- $14.10.
$390 put. Low- $8.00. High- $13.05. Close- $10.10
And the chart from Friday:
Click to enlarge
The last two charts trigger my salivary glands.
In future articles, I will get into specifics as to how you could have played this type of movement. It's obvious, though, that you could enter both legs of the trade at the same time and settle for a small profit by offsetting a loss on one side of the trade with a bigger gain on the other. That's the textbook design of a strangle. Of course, you can get fancier with your timing and profit from both ends or lessen the loss on one side of the trade.
In any case, investors are always looking for ways to generate extra income. Often, it's a flight to perceived safety via dividend stocks. When a stock like AAPL does not pay a dividend, covered calls represent the most common way to enhance your returns. Investors who are more comfortable with options will sell puts to add long exposure to their portfolio while generating income. I view strangles on stocks that exhibit wide intraday trading ranges more often than not as another potential way to not only generate additional profit for your portfolio, but to bide your time as your buy-and-hold long position appreciates.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.