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, Joe Springer (399 clicks)
Long/short equity
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Authorities have been on the case of the dastardly Brazilian Strangler since June 21 when, with great malice, we made hypothetical purchases of a call option and a put option for Petrobras (NYSE:PBR).

We named our trade the Brazilian Strangler - one way to game volatility on a stock is with a "strangle." A strangle is an options strategy that has a call option that profits if the stock moves up a lot, and a put option that profits if the stock moves down a lot. Remember, we are not advocating this trade, this is meant as a learning exercise to see how strangle option strategies work. Here again is a little background for newbies:

a call option is the right but not the obligation to buy a share of stock at an agreed upon price until an agreed upon date. A put option is the right but not the obligation to sell a share of stock at an agreed upon price until an agreed upon date. The agreed upon price is the "strike" and the date that the rights end is the "expiration." Options like this also trade in lots of 100. So each call and put costs 100 times its listed price and confers rights on 100 shares.

At the time the call we bought was the $22 strike for $145 and the put was the $18 strike for $146.

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PBR has since been throttled on a less than impressive fuel price increase in Brazil, but then rallied along with the price of gas after the meeting in Europe 10 days ago. For a while the put was in the money as PBR sunk under $18, but the rally puts both options out of the money for the time being.

So what we end up with is two options that once again would expire worthless if today were expiration - but these options don't expire until January. We've lost a little bit of time premium but have a while yet to see if this was a good trade.

(click to enlarge)

Conclusion

Buying call and put options means that your investment is losing money from the second you own the option if it does not go the way you thought it would. Options have a time premium that evaporates as expiry gets closer, and though its only been a couple of weeks the Brazilian Strangler that cost us $291 last traded at $267. There is plenty of time left, but we have been suggesting that investors should consider writing options instead of buying them. So far this trade is showing that the seller and not the buyer is making money, and that is the case quite often when it comes to options.

When we set the hypothetical trade for PBR we also set hypothetical options trades for Royal Dutch (NYSE:RDS.A), Total (NYSE:TOT), EnCana (NYSE:ECA), Suncor (NYSE:SU), Penn West (NYSE:PWE), BP (NYSE:BP), and Statoil (NYSE:STO). After two and a half weeks only Suncor and PWE are profitable on options bought while PBR, ECA, TOT, and RDS.A are profitable alright - for the seller.

We'll continue to monitor the Brazilian Strangler trade as it approaches expiration in January, until then, better sleep with the lights on.

Source: Bloodied Brazilian Strangler Cornered In Deadly Game Of Cat And Mouse