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Interesting Option Trading Strategy: Short PCLN strangle over weekend

|Includes:The Priceline Group Inc. (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