We have a portfolio called the Last Minute portfolio. It remains in cash all week until Thursday near the close when calendar spreads are placed, buying options with 8 days of remaining life and selling options that will expire the very next day. These spreads are designed to make money if the stock (SPY) changes by less than a dollar on Friday (we set money aside to make a hedging bet on Friday if it becomes necessary).
On Thursdays which precede the government monthly job reports, a different strategy is employed (we have noticed that volatility tends to be extreme on those days when the jobs report comes out). Rather than betting that SPY will fluctuate by less than a dollar, we buy either a straddle or strangle that will most likely make money if SPY moves by more than a dollar on Friday.
This was the Trade Alert we sent out to Insiders on Thursday with about 10 minutes remaining in the trading day:
“July 7, 2011 Trade Alert – Last Minute Portfolio
With the government jobs report due tomorrow, we would rather bet that the stock moves by a dollar or more rather than placing calendar spreads that make a gain only if the stock moves by less than a dollar. We will invest only about a quarter of our available cash:
BTO 30 Jul2-11 135 put (SPY110708P135)
BTO 30 Jul2-11 136 call (SPY110708C136) for $.68 (buying a strangle)”
With SPY trading just about half way between $135 and $136 Thursday afternoon, we decided to buy the above strangle rather than a straddle. If the stock had been closer to one particular strike price, we would have opted for a straddle instead.
We bought 30 strangles for $68 each, investing $2040.
If at any point on Friday, SPY changed in value by more than $1.00 in either direction, we could probably sell those options at a profit. (At any price above $136.50, the calls could probably be sold for more than $68 we paid for the strangle, and at any price below $135.50, the puts could be sold for more than we paid for the strangle.) A small amount could also probably be gained by selling the other side of the strangle as well (unless the stock moved well more than a dollar).
When the government report came out on Friday, the market was spooked by the poor numbers – Non-farm private payrolls were expected to grow by 110,000 while the actual number was a disappointing 57,000. Total nonfarm payrolls grew only 18,000 compared to an expected 80,000 (government jobs dropped by 39,000). The stock (SPY) opened down $1.40 and moved down almost $2 during the day.
Early in the day while the 135 puts were trading at about $1.00, we placed a limit order to sell 25 of our 30 puts at $1.10, and the order was executed about a half hour later. This would insure that we made a profit for the day no matter what happened from that point forward. We were hoping that either the stock moved lower and we could sell the remaining 5 puts for a higher price or the stock would make a big move upward and maybe we could collect something from selling our 30 calls at the 136 strike.
The stock continued to fall, and later in the day we placed an order to sell the remaining 5 puts. We collected $1.52 ($152) each for them. That wasn’t the absolute high for the day but it was darn close. Had we waited until the close, we would have only received $.37 for those puts, and lost money on our investment. This proves the value in taking a profit on the great majority of positions whenever it might come up rather than waiting for a possible windfall gain if the stock continues in only one direction.
Bottom line, we collected a profit for the day of $1363 after commissions on our investment of $2040, or 67%.
Straddle buyers like volatility as much as we don’t like it in our other portfolios. There are many ways to profit with options. It is best to remain flexible, and use the option strategy that best matches current market conditions. Buying straddles or strangles when option prices are low and volatility is high is one very good way to make extraordinary gains, as we happily did last week.
The downside to buying straddles or strangles is that if the market doesn’t fluctuate much, you could lose every penny of your investment (although if you don’t wait too much longer than mid-day on the day options expire, even out-of-the-money options retain some value and should be able to be sold for something). This makes it a much riskier investment than the other option strategies we recommend at Terry’s Tips. However, straddle- or strangle-buying can be quite profitable if the current market patterns persist.