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)
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)
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