Options Trade of the Day: An EMC Corp. Straddle

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Options traders are apparently expecting a sizable move out of technology concern EMC Corp. ( EMC ). On Monday, Elizabeth Harrow reported on a long strangle , involving the April 22 call and April 19 put strikes. Today, another trader has initiated a shorter-term straddle, centered on the October 21 strike. Since the stock is being squeezed into resistance at the $21 level by support from its rising 10-week and 50-week moving averages, options traders apparently believe that something is bound to give, sooner or later.

Weekly EMC chart with 10-week and 50-week moving averages

Drilling down on today's EMC straddle, the trader purchased 500 October 21 calls for the ask price of $0.54, or $54 per contract, on the Chicago Board Options Exchange ( CBOE ) at 1:33 p.m. Eastern time. As you would expect with a straddle position, the other half of this trade crossed on EMC's October 21 put, where 500 contracts changed hands at the same time on the same exchange for the ask price of $0.85. By implementing this strategy, the trader needs EMC to move sharply by the time these options expire at the close of trading on Friday, Oct. 15; direction doesn't matter.

EMC October 21 call and put volume

For those not familiar with this options strategy, a straddle is the simultaneous purchase or sale of an equal number of puts and calls on a given underlying stock with the same expiration and strike price. The straddle purchaser is looking for a large move by the stock, one that exceeds the focus strike by more than the amount of the premium paid for both options.

The Anatomy of an EMC Corp. Straddle

Drilling down on today's EMC straddle, the trader purchased 500 October 21 calls for $27,000 -- ($0.54 * 100) * 500 = $27,000. At the same time, the trader also purchased 500 October 21 puts for $42,500 -- ($0.85 * 100) * 500 = $42,500. The total outlay for this position would be $69,500 -- $42,500 + $27,000 = $69,500.

EMC strangle breakdown

There are two ways of determining the maximum profit on a straddle position. If EMC jumps higher, then the maximum profit is theoretically unlimited, as there is no cap to how high the shares can rally. If EMC plunges, the maximum profit is limited to the purchased strike minus the total debit paid. For this position, the maximum profit from a downside move is $19.61 -- 21 - 1.39 = $19.61 -- or $1,961 per contract.

There are also two breakeven points for this position. They are calculated by adding and subtracting the net debit to or from the focus strike. For the example, the breakevens are $22.39 -- 21 + 1.39 = $22.39 -- on the upside, and $19.61 -- 21 - 1.39 = $19.61 -- on the downside. Finally, the maximum loss is limited to the net debit paid upon entering the position. Below is a chart for a rough visual representation:

EMC straddle profit/loss chart

Implied Volatility

Traders should not be afraid of rising implied volatility following the initiation of a straddle position. An increase in implieds boosts the value of the purchased options, allowing the trader to collect a higher return by selling (to close) the position. At the time of the trade, implieds for the EMC October 21 call were 28.14%, while the implied volatility for the October 21 put rested at 28.12%. For comparison, the stock's one-month historical volatility arrived at 26.43% as of the close of trading on Tuesday.

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This article appears in: Investing , Options

Referenced Stocks: CBOE , EMC

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