Playing the range: Short strangles


Even when things are going well at a company, shares may churn in a range for months as they struggle against levels established months or years previously. As a result, stocks often spend long periods of time confined by support and resistance levels.

While this can prove frustrating for investors who own stock, option traders can exploit the sideways trend by selling both calls and puts in what's known as a short strangle. That allows them to collect two premium payments while facing the risk of loss on only one of those two because a stock cannot move up and down at the same time. (See our Education section)

HBC Satellite-television company DirecTV, for instance, peaked around $43 in early 2000 when the dot-com frenzy reached its zenith. Late last year, it briefly touched that level before pulling back, prompting traders to sell a series of calls and puts that expire in January 2012. Translation: They think DTV will spend all of 2011 in trapped in a range.

Luxury-denim company True Religion dropped after a bad earnings report on Nov. 4. But the stock was near support and traders sold the November 19-20 strangle.

Drug maker Amarin more than doubled between November and early January, but traders saw it calming in the next few months and sold calls and puts.

British megabank HSBC Holdings spent most of last year grinding sideways. In November, a trader sold the January 50 puts and the January 57.50 calls, accurately predicting that it would remain between those strike prices (dark orange lines on chart above).

(Chart courtesy of tradeMONSTER)

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

Copyright © 2010 OptionMonster® Holdings, Inc. All Rights Reserved.

This article appears in: Investing , Options

Referenced Stocks: AMRN , DTV , HBC , TRLG



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