Thanksgiving has come and gone and we’re quickly approaching the end of the year. It’s about this time when investors start thinking about trading strategies for the coming year. What’s going to be successful in 2018? What are the new trends going to be?
Usually, a new trade theory involves an expectation of some asset class or stock going up (or down). For instance, you may feel 2018 is going to be a great year to buy gold. Or, maybe you think 2018 is when brick and mortar retail companies are going to hammered into oblivion.
Of course, with options, you don’t have to necessarily choose a direction for an asset. You could just bet on the asset moving (or not moving). Essentially, you would be making a bet on volatility, or lack thereof.
Take the tech sector for example. Investors may believe tech stocks are going to be more volatile than normal in 2018. They may not have a strong opinion on whether tech is going to be bullish or bearish, just that stocks in the sector are going to be moving.
Conversely, some investors may expect the exact opposite. Now normally, tech is considered one of the more volatile sectors, with a lot of big movers. Because tech can often be associated with higher volatility, there may be more opportunities for profit by betting against a big tech move.
In fact, this is exactly what a trader did recently using options on PowerShares QQQ ETF (NASDAQ: QQQ). QQQ is a heavily traded ETF which tracks the Nasdaq 100 index.
Specifically, the trader sold about 1,000 straddles in January QQQ options. Selling a straddle involves selling a call and put at the same strike in the same expiration. In this case, with QQQ at around $156, the straddle traded was the January 156.
The trader sold both the 156 call and put and collected a little under $6.00 on the trade. That means as long as QQQ ends up between roughly $150 and $162 by mid-January, the straddle seller will collect around $600,000 in premium. Of course, should QQQ make a big move in either direction, the trader will lose $100,000 for every dollar the ETF moves outside the profit range.
That’s clearly a ton of risk to take, which is why most traders should never sell straddles. However, this trader obviously is willing to take the risk. If you think about it, there probably isn’t all that much which could occur between now and the middle of January which could severely alter the tech market. QQQ is still an ETF, which means it moves slower than individual stocks. Plus, you have a lot of down time over the holidays.
Still, I wouldn’t do this type of trade due to the risk. If you like the idea of betting against tech volatility, you can turn this trade into an iron butterfly and significantly cut down on your risk and margin requirements. All you have to do is buy a strangle (call and put in the same expiration but at different strikes) around the short straddle and you have protection.
For example, you could buy the January 151 put and 161 call while keeping the short 156 straddle and you suddenly have an iron butterfly on your hands. Instead of making $6 at expiration, you’d only make around $4 but you also can’t lose more than $5 on the trade if it moves against you.
It’s always a good idea to have defined risk when dealing with options, regardless of your level of experience. Iron butterflies are one way to limit your risk while still allowing you to collect a decent amount in premium on your trade.