1) Higher priced straddles are better than lower priced straddles. Avoid low strike price straddles because they have less profit potential to the downside. For instance, if I buy a straddle at the $7.5 strike for $4, my maximum gain on the downside is limited to <100% ($3.50 max gain/ $4.00 price). Higher strike price straddles have more profit potential to the downside than lower strike price straddles.

2) Once a straddle position hits a breakeven point, sell the opposite side of the straddle. For instance, if I paid $10 for a straddle purchased at the $50 strike (long a $50 call and a $50 put), and the stock has advanced to $60 (my upside breakeven point), I will sell the $50 put. At this point in the trade, you generally have a nice profit.

3) Once you have sold 1 side of the straddle, manage the position as you would any other long or short position. Establish an exit point and hedge to protect profits. Protect your profits and do not let your winner become a loser. I generally use the 50d moving average as a sell signal or as the impetus to hedge the position if this average is broken.

4) Let the winners run. Stocks can maintain trends for far longer than one might think.

5) If a straddle position is not moving much, consider selling out of the money (OTM) calls and puts (sell a strangle) to generate income. This can be dangerous because the stock can explode in either direction at any time and you can miss out on a large percentage of this move if you are short an OTM call/put. For this reason, I prefer to sell OTM spreads.

6) On losers, ALWAYS close out 2 months prior to expiration to minimize losses.

As with any trading guidelines, there are always exceptions and conditions unique to each stock.

Coach Fitzg

BOUGHT 1 R JAN11 40C for $8.53
BOUGHT 1 R JAN11 40P for $5.92

The downside break even for this straddle was $25.55 ($40-$14.45) and the upside break even was $54.45 ($40+$14.45). Early in 2010, R traded down to the $31- $32 range but then reversed and traded up  to the $47 range. This was followed by a long lateral move and R closed on 11/19/10 (2 months prior to JAN11 expiration) at $43.81. So on 11/19/10, I…

SOLD 1 R JAN11 40C for $3.70
SOLD 1 R JAN11 40P for    $.80

The key to limiting losses is to close losing straddles out 2 months prior to expiration and avoid the rapid premium decay that occurs during the last 2 months.

Coach Fitzg

BOUGHT – 1 SOHU JAN12 40C for $10.16
BOUGHT – 1 SOHU JAN12 40P for $7.30

Our upside breakeven is $57.46 ($40.00+$17.46) and downside breakeven was $22.54 ($40.00-$17.46).
Here are the specific numbers for our 2 criteria:

Criteria 1) The stock must be near a 2 year low in its’ 30 day historical price volatility.

On 7/21/10, SOHU‘s 2 year high/low in 30d historical volatility was 133/24. On 7/21/10, SOHU was at 24 which was a new 2 year low. Again, this means options should be relatively cheap and SOHU may be ‘waking up’ soon and price movements could become more volatile.

Criteria 2) Purchase the straddle for about half (.5x) the recent price range.

On 7/21/10, the JAN12 expiration is 549 calendar days away or 380 trading days away. I want to look back at the price range for  half the period left until expiration or 190 trading days (380/2=190). SOHU‘s high/low prices during the last 190 trading days were $71.50/$40.05. The high occurred on 10/23/09 and the low occurred on 6/29/10. The range is $31.45 ($71.50-$40.05=$31.45). So if I can purchase the straddle for about half of the recent range, or $15.72 ($31.45/2=$15.72), I would have twice the time for SOHU to move half its’ recent range to breakeven. I ended up paying a little more for the straddle ($17.46 vs. target of $15.72) but I sometimes relax my criteria if I think it is a good opportunity.

In part 5, I will walk you through a losing straddle trade and what I do to minimize losses.

Coach Fitzg

2) the straddle price must be around half (.5) of the recent price range of the stock.

I target straddles with expiration dates that are 9 – 18 months out. Today, I am looking at straddle expirations in JAN12 which is about 140 trading days away from now. To see if a straddle is priced attractively, I look at the recent price range for half the time period until expiration or 140/2 = 70 trading days. A simple scan using commonly available charting software subtracts the lowest price of the last 70 trading days (let’s say $50) from the highest price of the last 70 trading days (let’s say $90) which results in a price range of $40 ($90-$50).  If I can purchase this straddle for $40/2 = $20, I will consider purchase. First, I research the stock to make sure it is not involved in any unique situations (mergers,  acquisitions, etc.). If there are no red flags on the stock, I will purchase this straddle. Let’s say the ticker is XYZ and it is trading at $70. I would purchase 1 JAN12 70C and 1 JAN12 70P for $20. My breakeven point for the upside is is $90 ($70 strike + $20 cost) and my breakeven point for the downside is $50 ($70 strike – $20 cost). I have twice the time (140 days until expiration) for the stock to move half of its’ recent range ($40/2 = $20) to breakeven.

In Part 4, I will take you through the details of the SOHU straddle that is part of The Trade Coach Model Portfolio with all the real numbers that were calculated for that trade. In Part 5, I will take you through a losing straddle trade so you get a balanced picture. In Part 6, I will go through some general guidelines and tips on how to manage a straddle once you have entered the trade. Look for these posts over the next week.

Coach Fitzg

Low HV: INTC current 30d HV:16.97 (2 yr hi: 84; 2 yr low: 16) INTC is currently near its’ 2 yr low

High HV: LVS current 30d HV: 53.05 (2 yr hi:317; 2 yr low:33)

Using a commonly available charting and scanning tool, I plot 30d HV and look at a 2 year time frame. I am only interested in stocks where 30d HV is near (within 5%) a 2 year low. There are 3 reasons I want this condition:

1) If it is near a 2 year low in 30d HV, option prices are likely to be low as well and the straddle is relatively cheap.

2) Going forward, it is likely that 30d HV will go higher as it reverts to its’ mean. This means that the option prices for my purchased straddle are likely to rise as well.

3) When a stock ‘goes to sleep’, it often moves rapidly up or down after ‘waking up’.

While this may seem complicated, in practice it is quite simple. Annual subscribers will be able to obtain everything you need from me to be able to perform these candidate searches on your own. Tomorrow, I will discuss the 2nd (of 2) criteria I look for, which is; 2) the straddle price must be around half (.5) of the recent price range of the stock.

Coach Fitzg

We update our Watch List on a regular basis and organize the Watch List generally by different strategies, though stock behavior can change our strategy interest regularly or apply to multiple strategies.

To see our current Watch List, go to the “Strategic Analysis” page and on the right hand side you will see “The Trade Coach’s Model Portfolio”.  Under this heading you will find our “Watch List”.  Simply click on the “Download PDF” link and the file will open as a separate document.

Under “Straddle/Strangle Strategy”, you will see the following:  “A daily search is done for straddle candidates and will be posted as appropriate.”  Over the next few days, we will provide more detail on the process used to identify straddle candidates.

Tomorrow, we discuss the 1st (of 2) criteria we look for, which is:   1) The stock must be near a 2 year low in its 30-Day historical price volatility.

Coach Fitzg

Earnings are out today after the close with the CC following at 5:00 p.m. EDT.  It will be interesting to see the results and what MGT says about ongoing litigation, new licenses and/or renewals.

There is a fair amount of chatter on the discussion boards that suggest RMBS may have sandbagged the estimates, and will announce a significant upside surprise.  We’ll see.

Short interest has been shrinking, Money Flow is steady and the stock’s Accumulation has been steadily rising.  All of these factors suggest that the big money expects good results and that the litigation will come down on RMBS‘ side or result in settlements.

We are standing pat until after earnings.  With our position heavily overweight already, we don’t see a compelling reason to increase our risk until good news is announced.

Coach BD

Just as we were about to issue a possible stop-loss alert on PGH at midday, the stock did an about face and climbed steadily higher for the remainder of the trading session.  The day ended as a high volume reversal day with its highest volume of the year… exactly what we like to see when one of our positions tests support, which PGH did today.  It bounced strongly off of its 50-Day MA at more than twice its normal volume… a very bullish sign.   Both Money Flow and Accumulation/Distribution indicators were positive, giving us supporting confirmation of the positive nature of the reversal.

Next stop… watch for a follow-up day with a close back above its 20-Day MA.

Coach BD

Renewed their license agreement with AMD late this afternoon.  This is very significant because the first license did not include any AMDacquistions during the licensing period.  Since then, AMD acquired ATI, a significant controller technology company.  This bodes well for future deals with controller companies like NVDA, because this new deal almost surely includes licensing for RMBS controller technology as well.

See the link below from the IV RMBS Discussion Board and read through many of the posts related to  this deal.  It is significant.

http://investorvillage.com/mbthread.asp?mb=3666&tid=8799820&showall=1

Coach BD

One of our basket of Canadian Royalty Trusts, PGH has broken out on its Daily chart.  It has also broken out on its Weekly chart and in the process, taken out the overhead resistance of its 200-Week MA.  PGH has also moved above its 50-Month MA on the LT Trend.

We like a 2-5% opening entry here with the goal that we may own 3-5 of these Trusts at a total investment of no more than 10% of our Core Portfolio.  The Trust is currently paying a monthly distribution of $.07 / Unit which translates to an annual return of ~7.5%

Though the tax status is undetermined at this point, past distributions have generally been “qualified” which means they are taxed at LT Capital Gains rates rather at ordinary income tax rates, making it an excellent candidate for a spot in your after-tax trading or investment account, rather than in an IRA account.

Other CAD Energy Trusts we are watching for entries are… BTE, ERF, PDS, PVX & PWE

Coach BD