Why traders are turning to strangles

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When in doubt, sell premium: That's what some traders were thinking yesterday.

optionMONSTER's monitoring programs detected unusual call and put activity in several companies as investors used so-called strangle trades to turn time into money.

The most noteworthy transaction was in Men's Wearhouse, where an investor sold 2,500 each of the January 24 puts and the January 25 calls for $0.90 and $1.05, respectively. He or she will keep the $1.95 premium if MW closes between the two strike prices on expiration.

MW The trade comes after weak fourth-quarter guidance caused the apparel stock to gap lower on Dec. 8. It seems to have found support around its current level, but the trader may expect more selling if it climbs back toward $25. MW ended yesterday's session up 1.61 percent to $24.62.

Auto-parts maker Magna International, which is near an all-time high of $52.42, drew a similar trade: Blocks of about 1,300 contracts were sold in both the June 40 puts for $1.30 and the June 60 calls for $1.60. The trade will earn a maximum profit of $2.90 if MGA closes between $40 and $60, which is more than 15 percent above and below its closing price of $50.50 yesterday.

The strangles come with the S&P 500 stalling around the same point where it traded immediately before the 2008 market crash. Many individual stocks have encountered resistance at comparable levels on their charts, and some traders may expect the broader indexes to follow a similar pattern.

If the market does remain trapped in this range, it makes sense to use market-neutral strategies that earn money from the simple passage of time rather directional trades that need stocks to rise or fall. (See our Education section)

Another strangle was detected in Mosaic, a fertilizer stock that almost doubled between early July and mid-November but has been drifting lower since. This time, 3,200 March 65 puts were sold for $5.10 and 3,200 March 72.50 calls were sold for $3.05, resulting in a total credit of $8.15.

MOS fell 1.61 percent to $65. Unlike MW and MGA, it's near the lower end of the strangle's range, which suggests that the trader sees less downside risk. He or she might expect it to hold support around the $64 level where it gapped higher on Oct. 8.

The activity in MOS was within the stock's normal trading volumes. In MGA and MW, however, activity was unusually heavy, with total options volume 41 times and 178 times above average in each, respectively.

(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: MGA , MO , MW

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