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David Jay
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Initially David trained as a medical doctor but since then left the profession to pursue his passion in the financial markets. Currently David is a full time options trader and entrepreneur and writes a blog about his trading insights at blog.theoptionstradingcourse.com.
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The Options Trading Course
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The Options Trading Course Blog
  • Interesting Option Trading Strategy: Short PCLN strangle over weekend 6 comments
    Aug 12, 2011 6:09 PM | about stocks: PCLN

    The recent market crash has elevated volatility throughout the markets and this has brought on both opportunity and peril to investors.  

    The initial period of the market correction was highly profitable for long straddle trading, however now that the market has digested the news of the S&P credit downgrade of the United States, the volatility will probably tend to trend lower.

    With this in mind I've opened a short strangle on PCLN just before the close today, Friday.  I aim to benefit from the large time decay over the last weekend prior to expiration and close the position on Monday morning.

    In general short strangles can be quite a risky trade due to the large loss potential.
    However following detailed historical analysis I've quantified expected price movements over the weekend.

    From the graph above you can see that the close to open price change over the weekend is only 0.33 standard deviations with one standard deviation currently 17 points.  

    From the graph above you can see that only 4% of movements are over 1 standard deviation on Mondays in 2011 (I changed the value in excel).  The rest of the value are for movements greater than 0.5 standard deviations and you can see that also for 2010 Monday tended to be much less volatile for Close to Open movements.  This indicates that PCLN is relatively insensitive to weekend events.

    If I take a conservative figure of a 0.9 standard deviation movement over the weekend, this will mean that on Monday PCLN should trade between 487.37 and 518.13.  Currently PCLN is trading at $503.  This is equivalent to a movement of 3.1% in either direction.  

    I shorted a PCLN straddle for $20.55.  This involves selling a 500 put option and selling a 505 call option. With a theta of 175, this means that the value of PCLN options will be eroded by time decay by a figure of $1.75 each day.  On Monday, with PCLN trading at the same price, the straddle should be worth $15.69.


    The graph above shows the profit and loss graph for this options trading strategy.  You can see that my profit range will be between $485 and $519 for this short strangle trade.  This is well within my very stringent range requirement of between $487 and $518 and leaves me with a decent margin of safety.  

    This option trade is obviously highly sensitive to volatility with a vega of -46.  If the markets continue to calm and volatility decreases this will aid my position and increase the potential profit. Conversely, if volatility picks ups this will negatively impact my trade.

    Please feel free to comment about this trade and add any insights or ask questions.

    You can learn more about option strategies at my blog on The Options Trading Course.
    Stocks: PCLN
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Comments (6)
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  • wify
    , contributor
    Comments (22) | Send Message
    Great article David! Opportunities of pairs trading usually last for only a short-period of time thus quick response to market movements is required, which can only be achieved by high degree of automation. I will definitely share more if I find some more time. Looking forward to hearing from you. Thanks.
    27 Aug 2011, 07:00 AM Reply Like
  • Maverick86
    , contributor
    Comments (72) | Send Message
    Why did u buy the strangle back on monday and not wait to expire worthless?
    23 Jun 2012, 04:20 PM Reply Like
  • David Jay
    , contributor
    Comments (3) | Send Message
    Author’s reply » This was a calculated trade to take advantage of the massive time decay over the weekend, and the margin of safety was calculated using historical movements over the weekend.


    To leave the trade open longer would 1) go against the initial reason behind the trade of capitalizing on the time decay over the weekend 2) expose me to significant risk in terms of price movement. PCLN is in general a very volatile stock and leaving this open any longer could have exposed me to large losses if the stock experienced a sudden price swing.


    Good question. You can feel free to browse my personal blog at http://bit.ly/niaTcu and leave comments / questions to understand the tactics I use.
    24 Jun 2012, 10:29 AM Reply Like
  • Maverick86
    , contributor
    Comments (72) | Send Message
    I get it, thanks. And last, coudn't you just use contingency orders just in case the price of the stock went outside you confortable zone?
    24 Jun 2012, 11:46 AM Reply Like
  • dudi_j
    , contributor
    Comment (1) | Send Message
    You can set stop losses, but with multipart complex option trades they can be difficult to manage.


    Pcln also exhibits rather low liquidity on the options and so the price could skip the stop loss. This is especially true when exposed to overnight price movements, which can be very large and reflect events that occurred after market close.
    25 Jun 2012, 11:20 AM Reply Like
  • Maverick86
    , contributor
    Comments (72) | Send Message
    Im thinking about doing a short strangle with MSFT. Anybody has something to add on that strategy? thanks
    25 Jun 2012, 01:47 PM Reply Like
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