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Expert option traders wait for volatility to initiate long strangles. A long strangle is an option strategy that allows a trader to profit whether the stock moves up or down. However, when the market moves sideways, a severe capital loss will occur if the positions are not closed out in a timely manner, therefore please do not try this strategy if you are a beginner.

There are currently three stocks on my radar that should experience increased volatility in the short term given the recent events: Bank of America (NYSE:BAC), Apple (NASDAQ:AAPL), and Netflix (NASDAQ:NFLX).

Let us start with Bank of America. Its stock has been hovering near its 52-week lows from the plague of unending lawsuits and website problems. Investors are split on a decision whether the stock is still a value play. Quite a number of fund managers are still reassured that litigation losses will spill over to company’s margins in subsequent quarters. On the other hand, last time I heard this in 2009, I went against the grain and began buying $3.50 strike call options, making a small fortune. The stock was trading near $4.00 and every money manager was dumping shares like it was Armageddon.

Now we're in 2011, and I am a bit more of an optimist on Bank of America and the overall market, hence my long strangle will place 60% more weight on the call option and 40% on the put option. What this means is that I might consider buying 6 contracts of the call option and 5 contracts of the put option.

Bank of America Options (as of 10/7/2011)

Stock Price $5.90

Expiration

Strike Price

Type Premium

Cost Basis

Delta Gamma Theta Implied Volatility (IV)
Jan. 2012 (BAC) $6 Call $0.99 0.58 0.16 0.00 79.10
Jan. 2012

(BAC) $5

Put $0.66 (0.27) 0.11 0.00 92.27
Net Debit -$165

Learn the Greeks!

Delta: 0.58 means that it has 58% chance of expiring in-the-money, and also means that for every $1 increase, premium will increase by $0.58

Gamma: 0.16 is the increment that delta will change for each dollar increase, otherwise known as the “Speed of speed”. Gamma is normally larger for at-the-money options and will fall incrementally lower for both in-the money and out-of-money options.

Theta: 0.00 is the amount your option will lose with passage of time each day, if the stock doesn’t move at all. Theta, otherwise known as “time decay” will increase as the option nears its expiration and enters its last month.

Apple (AAPL) Options (as of 10/7/2011)

Stock Price $369.80

Expiration

Strike Price

Type Premium

Cost Basis

Delta Gamma Theta Implied Volatility (IV)
Jan. 2012

(AAPL)$380

Call $29.10 0.52 0.01 (0.17) 39.52
Jan. 2012 (AAPL)$360 Put $28.70 (0.39) 0.00 (0.14) 45.25
Net Debit - $5,780

And of course the future of Apple is already in question with the recent 2% stock dip. Will Tim Cook overpromise and fail to deliver, or will he meet analyst expectations by continuing the innovation momentum? Again, no one knows how investors will react but volatility is certain, and that is all you are looking for in this option strategy.

Please do not just follow the chart above, instead choose option expiration dates that suit your risk appetite. Give yourself more time if necessary or buy a more out-of-money option that is less expensive, but this may work against you if the stock remains hovering in a tight range.

Netflix (NFLX) Options (as of 10/7/2011)

Stock Price $117.21

Expiration

Strike Price

Type Premium

Cost Basis

Delta Gamma Theta Implied Volatility (IV)
Jan. 2012

(NFLX)$125

Call $14.30 0.52 0.01 (0.09) 66.67
Jan. 2012

(NFLX)$110

Put $14.05 (0.35) 0.01 (0.08) 75.34
Net Debit - $2,835

Netflix is another interesting scenario, since some investors wholeheartedly believe that the company’s best days are behind it. In my article “10 Value Stocks to Own In 2012”, I mention that Netflix is a value gem.…for now. The company has a business model that will constantly change, adapt, and evolve with competition, and that simply translates into higher beta (risk). This was evident as the stock lost approximately 60% since its July high of $290.

The online video streaming market is becoming increasingly competitive as Facebook is attempting to tap into the market. Netflix's recent pricing changes disappointed millions of users, but I applaud the management for making necessary changes to grow the right way. From a business standpoint, this move may be beneficial for its long term shareholders.

Bottom line: NFLX is experiencing increased volatility and has been trading with an oversold Relative Strength Index of 24 and far below its 50, 200 day moving averages. Currently there are a lot of traders on the sidelines waiting for the stock to signal any type of direction.

Source: Expecting Volatility: Option Strangle Could Be The Answer