If you are treating your investing like a business (like you should be) then one of the things you are doing is staying abreast of news. This is very important because certain things that happen in the market can have a huge effect on market movement. This is especially true of events like the financial state of Europe. With each new turn we have had huge market reactions. Some of those reactions took place and caused the market to move either up or down and sometimes with large gaps when the markets opened.
Keeping abreast of news can create opportunity to make a profit using options to capture market movement. One strategy that can be very popular is called a straddle.
Using a Straddle to Capture News Reactions
A straddle is a very popular strategy to use when volatility is increasing and when reactionary movements take place because world events, this is an easy to understand option play. In a nut shell, we simply buy puts and calls with the same strike price and expiration date so that we can capture price movement from a stock whenever it had larger moves up or down. With a trade like this we have limited downside (our premiums) but unlimited upside. Assuming the move is enough to cover the cost of a trade, it is profitable.
This last week is a good example of a price movement that one could capture if they followed what was happening. November 15-18 we dropped 2.73 points in the QQQ because of event that was going on in Europe that we could keep informed about. France and Germany were not seeing eye to eye on dealing with the bonds. France wants the ECB to keep the lid on bond yields and Germany did not think the ECB had the authority to carry on the bond purchasing operation.
This with yet another rift in solving the European debt dilemma and US Banks would continue to face rising risk, notably Spain and Italy. This renewed uncertainty would bring bearish reactions to the market. That is one of the major variables that hit the markets this week.
As a good investor watching the markets, we would know a reaction would be forth-coming because this has been the recent track record. We would expect the uncertainty again to influence the volatility and this is what we want in an option strategy like this. The strategy itself is direction-neutral but we want increased volatility to create consistent directional move.
As you can see on this chart, we had nice increase in volatility at the same time the markets reacted to the disagreements developing in Europe. Ideally a trade like this would profit much greater with low volatility and an explosive move in one direction, but these are harder to catch. Using current events and news can help us anticipate short term market direction and create income with options. Income is captured through the reselling of the option at a more valuable level then you bought it.
A simple variance of a straddle would be to buy the option the direction you believe the market would move. This is anticipatory and requires a strong working knowledge of news and current events.