By Greg Jensen
CEO and Founder, OptionsANIMAL
This weekend we will get to see one of the most anticipated movies in recent memory.
“The Hunger Games," a New York Times bestseller poised to be the next Hollywood blockbuster, is held in the same regard by many as was Twilight and Harry Potter. The excitement for me is not so much about how Katniss is going to do in the Hunger Games, but how I am going to take advantage of the opportunity it creates in the stock market.
The most common path investors take when looking at these types of movie releases is to buy the equity of the film production company releasing the film. In this case that company is Lionsgate Films (LGF). However, there are two problems with going straight bullish with LGF at this point. First, the stock is trading with a very high valuation. The P/E ratio for LGF is currently 76. That is high by any standard. The other problem is the stock has already had a bullish move year-to-date. On January 1, the stock was trading at $8 per share. Today it is sitting at almost $16 per share. This bullish movement has been of course in anticipation of this week’s release of “Hunger Games”.
The argument is that the stock has already moved. The old saying, “Buy the rumor, sell the news,” may fit very well in this situation. The options trader has a problem as well with the Implied Volatility (IV) being artificially heightened in expectation of a big move. IV is currently at 80. This comes from a stock that last year averaged IV in the range of 30-50.
Even so, there are trading strategies you can use to take advantage of this situation.
For example, you could apply a long strangle. The long strangle involves going long (buying) both a call option and a put options of the same equity, the options having different strike prices.
The long strangle makes a profit if the equity price moves far enough away from the current price in either direction. Thus, an investor may take a long strangle position if he thinks the underlying equity is highly volatile, but does not know which direction it is going to move. This position is a limited risk trade since the most a purchaser can lose is the cost of both options. At the same time, there is unlimited profit potential.
I like the long strangle strategy because it allows me to position myself bullish, but still have some downside bearish hedge, just in case I am wrong. This allows for a continuation of the bullish trend, but hedges my downside risk. The downside of a long strangle trade is that it is very expensive currently because of the aforementioned high levels of IV.
Another trade that allows a trader to sell the high levels of implied volatility (IV) is a credit trade. A bull credit trade, or bull put, can be applied to take advantage of high IV. A bull put is applied by selling a Put and buying a Put simultaneously. The Put that you short (sell) will be at a higher strike price than the Put that you long (buy). Therefore, you will generate a credit in your account. This credit is your maximum profit. The strategy with this trade is to capture the effects of time decay on the option sold, as well as take advantage of a bullish move in the stock. The put option that is purchased is your hedge in case the stock moves quickly in the other direction.
As with all trades it is important to have both a primary and secondary exit strategy. The primary exit strategy for this type of trade is to let both of the options that you hold expire worthless. The added benefit to this exit strategy is that you will eliminate the commissions on the back end of the trade by simply allowing the options to expire worthless. The secondary exit strategy can either involve closing out the position for a small pre determined loss or converting the trade into a collar trade.
“Sell to open” a July 50 Put for XYZ Corp. @ $1.50 per share and you “buy to open” a July 45 Put for XYZ Corp. @$.50 per share.
$1.50 - $.50 = $1.00
Your net credit on this trade would be $1.00 per share.
One contract (100 shares) per leg ( a total of 2 ) would generate a profit (credit) of $100.
Regardless of how the market decides to react to Katniss, Peeta and the rest of the cast from “Hunger Games,”I am positive that movie fans and critics alike will have an enjoyable weekend.