Weekly Stock Options Trading Tips: June 28, 2010

Stock Option Trading Idea of the Week

Buying Straddles with Weekly Options

Market makers could have bought an at-the-money put and call for a total of about $3.10 at the close Friday.  This is called buying a straddle.  If at any point next week, SPY changes in value by more than $3.10 in either direction, the straddle buyer of those options could close out the positions at a profit.  While in about half the weeks, the weekly change is less than $2, at some time during the week, the odds are better that the stock will trade more than $3 away from the starting price at some point during the week.

Straddle buyers like volatility as much as we don't like it.  What they like best is a whip-saw market where the market moves sharply higher (and they sell their calls) and then down (when they unload their puts).   There are many ways to profit with options.  That is a good thing for everyone.

What are the odds of making money by buying an at-the-money straddle, paying $3.10 for an at-the-money put and call with 7 days of remaining life for the options?  How many times in 2010 would such a purchase pay off?  The table below gives the answer:

Five times out of 25 weeks, if the holder of the options waited until the market closed on the day the options expired, they would have made a gain by selling the straddle.  Twenty out of 25 times they would have lost money.

The strategy would have done better if the holder waited until the stock changed in price by $3.50 and then sold the options - 4 additional weeks would have resulted in a gain for the straddle buy, making 9 gaining weeks out of 25 (36%), and 16 losing weeks.

If the straddle holder had been patient enough to wait until his investment doubled in value, he would have made his 100% once in 25 weeks, or if he had been lucky enough to wait until he had a 400% gain, he would have made that much once as well in that one week when the market crashed.

Meanwhile, we believe our Optimum Weekly Strategy will make a gain every week that SPY ends up changing less than $3.00 in one week.  For the last 25 weeks, we would have enjoyed a gain in 20 weeks, or 80% of the time.  If we can indeed make 8% in a week if the change is less than $2 for the week, we would have enjoyed that level of gains 11 out of 25 weeks, or 44%.

In conclusion, I much prefer the risk-reward potential of the Optimum Weekly Strategy compared to buying straddles with the Weekly options.  If I were to try buying straddles, I think a better bet would be to wait until Monday afternoon to buy them because they would be cheaper (although some of the stock price change would already have taken place).

Any questions?  I would love to hear from you by email (terry@terrystips.com), or if you would like to talk to our guy Seth, give him a jingle at 800-803-4595 and either ask him your question(s) or give him your thoughts.

You can see every trade made in 8 actual option portfolios conducted at Terry's Tips and learn all about the wonderful world of options by subscribing here. Why wait any longer to make this important investment in yourself?

I look forward to having you on board, and to prospering with you.

Terry

Andy's Market Report

For several weeks I have mentioned the post options expiration (quadruple witching) bearish tendency. Fifteen out of the last seventeen years have all been witness to a market that has declined the week after June options expiration and this past week was no different. Indeed, the bears came out to play early and often. As a result, the Dow, Nasdaq 100, Russell 2000, and S&P 500 all finished the week decisively lower.

The market moved into the week in a short-term overbought state so the probability of a move lower had already increased dramatically. Couple the aforementioned with the bearish seasonal tendency and one can easily see why Mr. Probability was leaning towards the bearish camp this past week.

The bears did not hesitate to take action as soon as the opening bell rang Monday. The market opened with a large gap to the upside and sellers moved in right away and continued the sell-off into the early part of Friday's trading session.

As of Friday, the bears had become exhausted and it showed in the short-term oversold state that they had created. Typically, when the bears are able to push the market into a short-term oversold state the market will bounce over the next 1-3 days. Friday was day one of the bounce and with the quarter ending in two days and positive seasonality ahead of the July 4th holiday I would expect to see a continuation of the bounce as we move through next week.

Furthermore, there are a few other notable technical indicators that have reached a short-term extreme. Down Pressure has moved into a short-term extreme and over the past right years when it has reached such a level the next three days have been positive 75% of the time. Also, whenever the Percentage of Stocks > 10-day Average reached this type of extreme the S&P was up roughly 70% of the time. When the two indicators were in sync like they are currently the S&P was positive over 80% of the time. Certainly, the bulls should be happy over the next few days. After that, well, only Mr. Market knows where he will take us.

Economic news was mixed, so the move lower was, for the most part, technical. For the moment the debt crisis in Europe has passed and the new concern is housing. Many on Wall Street fear that the housing industry is nearing the edge of a double dip. The July data will certainly be closely watched and could lead to further declines as the market moves through the summer doldrums. Both existing and new home sales were significantly lower than analysts' expectations in May. Existing Home Sales fell to 5.66, well below the 6.1 million that economists' had predicted. Moreover, New Home Sales tumbled to 300,000 also well below the 430,000 and marking the lowest level on record.

The decline "officially marks the start of the double-dip in housing activity that we have been expecting for some time," said Paul Dales, an economist at Capital Markets in Toronto. The collapse in home prices and sales precipitated the U.S. recession that began in December 2007.

The one positive that came out of the poor housing reports - the 30-year fixed rate mortgage declined to an historical low at 4.69%. Although, with the unemployment rate at 10% it may be hard to drive demand for housing even with interest rates so incredibly low.

Andy

Overbought/Sold Condition Report

Overbought/Oversold as of June 25, 2010

Major Benchmarks

• S&P 500 (SPY) - 32.0 (neutral)

• Dow Jones (DIA) - 33.4 (neutral)

• Russell 2000 (IWM) - 44.9 (neutral)

• NASDAQ 100 (QQQQ) - 28.7 (oversold)