Short-Term Way to Play the Market's Increased Volatility

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 |  Includes: SPY
by: Jeffrey Keene

The SPDR S&P 500 (NYSEARCA:SPY) moved 10 points last week (August 8 to August 12) and 14 points the previous week (August 1 to August 5). Given those large swings and the increased volatility that we are witnessing on a daily basis, many option players are entering into short-term straddles, which allow them to profit if the market continues its significant daily movements (note: predicting the direction of the movement is unnecessary when purchasing a straddle as you purchase both the call and the put). The following trade provides option investors with a way to profit from the volatility while limiting downside risk: Purchasing the SPDR S&P 500 (SPY) August 120 Straddle for $3.25.

Breakdown:

In the money

The trade makes money if the SPY closes this Friday below $116.75 or above $123.25 (the strike price of $120 plus/minus the premiums paid of $3.25).

Out of the money

The most that can be lost on this trade is the $3.25 that was paid to purchase the call and the put.

Summary: The trade provides unlimited upside while limiting the downside scenario to a loss of only $3.25.

The reason I like this trade: This trade allows an investor to profit regardless of which direction the market goes as long as it moves significantly in one direction. With a ton of economic data due the rest of this week (housing starts, import and export prices, industrial production, producer price index/PPI, jobless claims, consumer price index/CPI, and existing home sales), I expect to see large daily movements until we hit Friday, which is equity option expiration and will only add to the volatility that we have witnessed lately.


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.