Based on the comments I received on this article, investors hardly have a consensus on where Nokia (NOK) will be a year from now. There are hardcore bullish people, who believe Nokia should be able to either turn itself around or get acquired by Microsoft (MSFT). Either way, the stock price should shoot for at least $5, maybe even higher. And then there are extremely bearish investors, who believe Nokia will follow the path of Research in Motion (RIMM), likely go bankrupt or get acquired at a even lower price.
Interestingly, out of these opinions, a consensus emerges. That is, Nokia's price is unlikely to stay where it is now. If investors were right about this disagreement of Nokia's future direction, we can apply an option strategy called "straddle" to make money out of Nokia, may it rise or fall sharply from the current price level. This strategy engages in buying and selling equal shares of call and put options with the same strike price and expiration date.
First, let's get the timing right. We know that Nokia will likely release new Windows 8 based phones during the last quarter of 2012, in sync with Microsoft's release of its new operating system. Nokia's share price is likely to become much more volatile by then. A straddle strategy should therefore be placed with an expiration date beyond October.
Nokia closed at $2.48 on Friday. Its $2.5 call and put options expiring January 2013 were priced at bid/ask $0.55/$0.59, $0.56/$0.57 respectively. Taking the average between bid and ask, each pair of $2.5 January 2013 call+put combo costs $1.14.
If Nokia's price goes below $1.24 (=$2.48-0.57) or above $3.62 (=$2.48+0.57), you start to make money. More precisely, the follow chart draws the expected profit with different Nokia price levels based on purchasing 10 pairs of Nokia January 2013 $2.5 call and put options.
(click to enlarge)
If Nokia goes bust and its stock price goes to $0 by January 2013, the maximum profit from the options, after deducting cost, is $1,360 (=$2.5*1000 - $1140).
If Nokia goes higher than $3.62, the straddle starts to make money, the higher the price the more the profits. Because of the asymmetry in Nokia's stock price potential (upside is not bounded), the potential profits are higher if the bullish case turns out to be true.
Of course, there is no free lunch. The risk in this strategy is obvious. If Nokia's stock price stays in the range between $1.24 and $3.62, the straddle will lose money. The maximum loss of $1,140 happens when Nokia closes at precisely $2.50 on the option expiration day in January 2013; both call and put options will be worth zero.