| Over the last few weeks we discussed either | | | | we say that we are uncertain about the |
| buying or selling calls or buying or selling puts in | | | | movement of the stock. Absolutely! So in addition |
| our option trading strategies. We determined, that | | | | to buying a call, we are also going to buy a put. |
| if the stock we are interested in is a good | | | | Holy cow batman, we are hedging our position on |
| company, meaning, that it has strong | | | | this stock! That is exactly correct. We are buying |
| fundamentals like good management, good | | | | a put in addition to buying the call, because, we |
| product, increasing revenues or increasing | | | | recognize that the company has good |
| earnings, we would purchase a call option in | | | | fundamentals, but the market (the investors |
| anticipation of the stock value increasing. On the | | | | buying or selling the stock) are showing signs of |
| flip side, if we noticed a company that was | | | | fear in the future fundamentals of the company |
| showing a poor performance or if we determined | | | | (this is called speculating, because investors can |
| that the overall market is bearish on the stock | | | | never really know whether or not the future of |
| (that is the market thinks the value of the | | | | the company is in peril until it is too late). By |
| company is overpriced), then we would buy a put | | | | buying a put option with our call option, our option |
| option in anticipation of the stock decreasing in | | | | trading strategy now will have the opportunity to |
| value. | | | | make a return on the stock as long as the stock |
| But, what if we are uncertain about the direction | | | | has the volatility that we are anticipating. |
| of the stock? For instance, what if the company | | | | So what are the costs? Typically, we will pay a |
| showed good earnings, but the market was | | | | small premium for each option we buy. For |
| bearish on the stock of the company. What do | | | | instance we will pay one price for the call option |
| we do? Well, I was explaining to a close friend of | | | | and we will pay another price for our put option. |
| mine the other day that when we are uncertain | | | | The great thing about investing in this option |
| about a stock but anticipate some volatility | | | | trading strategy is we are only risking our |
| (volatility is large swings in price, either upward or | | | | premiums. However, if the stock does have the |
| downward), we can either disregard the stock | | | | volatility we anticipate, we can close out one of |
| and move on to more certain investment | | | | our option positions as the stock moves |
| strategies or we can take advantage of the | | | | favorably towards the other option position. This |
| volatility in the stock. But, how exactly would we | | | | will limit our loss, but give us unlimited gains. |
| do this, you ask? Great question and below we | | | | The downside of this strategy is if the stock has |
| are going to walk you through how we would use | | | | no volatility and stays in a low volatile trading |
| this option trading strategy. | | | | range for the life of our option trading contracts. |
| So, we have decided to pursue a company that | | | | If this happens, we will lose our premiums. But, in |
| has a lot of volatility, but are uncertain about the | | | | my opinion, it is better to take a small premium |
| direction of the stock, so here is what we would | | | | loss versus buying into a stock (meaning investing |
| do to take advantage of a great opportunity. We | | | | a higher amount of capital) that is not going to |
| are going to purchase a call and a put. That's right! | | | | move at all or buying the stock and it plummets |
| we are going to purchase a call based on the fact | | | | and takes your capital with it. |
| that under the above scenario, the company has | | | | This strategy is called a Straddle. It is highly |
| good fundamentals (earnings, revenues, | | | | recommended for stocks with high volatility but |
| management, product, etc), so we buy the call in | | | | with the uncertainty of the stock's direction. |
| anticipation of the stock increasing. But wait, didn't | | | | |