Maj. Reisman: So what does that give you?
Capt. Stuart Kinder: Doesn’t give me anything. But along with these other results, it gives you just about the most twisted, anti-social bunch of psychopathic deformities I have ever run into! And the worst, the most dangerous of the bunch, is “Option Straddles.”

Lee Marvin – Maj. John Reisman
Ralph Meeker – Capt. Stuart Kinder
Paraphrased – Damocles
– (Move: Dirty Dozen)

Prologue

At first review, I see Straddles as “trades of opportunities.” Meant to be high risk and short duration position that is center around the knowledge of an imminent price change in the underlying stock. Long Straddles are the most successful during times of high market and underlying stock’s volatility. To have a chance with Straddles, I need to chase fundamentals, news, and earnings reports actively.

Without going through the details of the construction of a Straddle (the Internet has plenty of info), a Long Straddle is a debit trade strategy where I will buy both a Call and a Put at the same ATM strike. The expectations are that the underlying stock is about to make a wild swing (one way or the other), and one of those legs will end ITM enough to make a profit. Therefore, the price I would receive by selling the spread before expiration or by exercising one leg will generate more than the premiums I paid for both the legs.

As a Long Straddle introduction for me, I will reference Lockheed Martin (LMT). LMT is a position that I currently hold, and I know that they will have an earnings call on 10/22. I will look at a LMT’s history to see if a Straddle is plausible.

When to Straddle

Straddle strategies assume that I know something about what the stock is about to do. If I know that Lockheed Martin was about to announce a trillion-dollar sale or the invention of a super-duper fighter, then I would expect the stock to jump – may be much more than 3%. If I know that Lockheed Martin was about to declare bankruptcy or they are about to be sold to Walmart, then I would expect their stock to fall more than 3%. However, I am not plugged in enough to know this amount of insider details.

But what I do know is that every three months, Lockheed Martin reports their earnings for the quarter and publicize their financial expectations for the future. When I look back on Lockheed Martin’s last two earnings calls, I can see that LMT can quickly fluctuate 3-4% during the week of the earnings call. The question would be “is that enough to make a Long Straddle profitable?

Reviewing the Last 2 Earnings Calls for LMT

To see what effect Earnings Calls have on Lockheed Martin’s stock, I went back to the last two events to examine the outcomes.

April 23‘s Earnings Call:
4/22/19: LMT opened Monday morning at $315.08
4/26/19: LMT closed that Friday at $328.56
Price movement: +$13.48 or 4.3%
Is this enough to make money?

A hypothetical April Long Straddle for this week would look like this:

04/22/19: Lockheed Martin’s stock (LMT) current price = $315.08
04/22/19: I can buy a $317.5 ATM call option for $530 ($5.30 premium * 100 shares)
04/22/19: I can buy a $317.5 ATM put option for $730 ($7.30 premium *100 shares)
Both call/put options will expire Friday (04/26/19)
Total price paid for the LMT Straddle = $1,260.00 ($5.30 + $7.30 = $12.60 total premium) * 100 shares (+ trading fees)

By the end of the day the following Friday:

04/26/19: LMT closes at $328.56
04/26/19: Call exercised. Received $1,106 (328.56 – 317.5 = $11.06 * 100 shares
04/26/19: Put expires worthless.
04/26/19: Net loss = -$154 ($1,260.00 premium paid – $1,106 received) – fees
No Bueno!

July 23’s Earnings Call:
7/22/19: LMT opened Monday morning at $357.48
7/26/19: LMT closed that Friday at $369.78
Price movement: +$12.30 or 3.4%
Is this enough to make money?

A hypothetical July Long Straddle for this week would look like this:

07/22/19: Lockheed Martin’s stock (LMT) current price = $357.48
07/22/19: I can buy a $360 ATM call option for $410 ($4.10 premium * 100 shares)
07/22/19: I can buy a $360 ATM put option for $640 ($6.40 premium *100 shares)
Both call/put options will expire Friday (07/26/19)
Total price paid for the LMT Straddle = $1,050($4.10 + $6.40 = $10.50 total premium) * 100 shares (+ trading fees)

By the end of the following Friday:

07/26/19: LMT closes at $369.78
07/26/19: Call exercised. Received $978.00 (369.78 – 360.00 = $9.78 * 100 shares
07/26/19: Put expires worthless.
07/26/19: Net loss = -$72 ($1,050.00 paid – $978.00 received) – exercising fee
No good!

Buying a Long Straddle for either one of these past two earnings call would have been a loss. Let me see what would happen with the earnings call for this week.

Trading a LMT Straddle with Paper-Money

10/21/19: Lockheed Martin’s stock (LMT) current price = $374.18
10/21/19: I can buy a $372.5 ATM call option for $695 ($6.95 premium * 100 shares)
10/21/19: I can buy a $372.5 ATM put option for $505 ($5.05 premium *100 shares)
Both call/put options will expire this Friday (10/25)
Total price paid for the LMT Straddle = $1,200.00 ($6.95 + $5.05 = $12.00 total premium) * 100 shares (+ trading fee)

At expiration, if LMT closes above the break-even price of $384.50 ($372.50 strike + $12.00 total premiums paid), then I will make a profit through the call leg. The actual amount of profit will be that amount above $384.50. The put-leg will expire worthless.

Likewise, at expiration, if LMT closes below the break-even price of $360.49 ($372.50 – $12.00), then I also will make a profit via the put leg. The amount of profit will be the amount below $360.50. The call-leg will expire worthless as well.

Therefore, at the time I purchase the LMT Straddle for $1,200.00, LMT will need to rise more than 3.22% or fall more than 3.22% by expiration before this trade becomes profitable. But a 3% swing in any stock over five days is just not typical.

Now I will wait until this Friday to see how my paper-trade performed…

Tick-Tock…

10/22/19: Lockheed Martin Q3 Earning’s Report showed they had a pretty good quarter. But they also revised their future guidance to expect slower growth for the balance of the year. When the market opened 10/22, LMT fell 2.8% to $363.55.

The near 3% price movement is what this Straddle strategy was looking for, but it is not enough to make a profit. Now I wait until Friday to see if the rest of the marketeers sells off LMT and continue to push the price lower or if they shrug off this lower guidance and start buying LMT at a discount.

Tick-Tock…

By the end of the day Friday:

10/25/19: LMT closes at $370.77
Price movement: -$3.41 or 0.9%

The Marketeers received this earnings report with a placid yawn. There was the initial knee-jerk reaction, then after a quick reconsideration, was just shrugged off.

10/25/19: Call expires worthless.
10/25/19: Put exercised. Received $173 (372.50 – 370.77 = $1.73 * 100 shares)
10/25/19: Net loss = -$1,027 ($ 1,200.00 paid – $173.00 received) – exercising fee

My first impression to this week’s introduction into Straddles follows this movie scene from Armageddon – when they are naming the asteroid that is about to destroy the earth:

Karl: Sir I'm a retired Navy, I know a lot about classified. 
But one more thing, the person who finds her gets to name her, right?
 Dan Truman: Yes, that's right.
Karl: I want to name her Dottie after this week's Straddle review. 
She's a vicious life sucking bitch from which there is no escape. 
-  Armageddon (Movie)
- Paraphrased by Damocles

I may need more research on Straddles….

P&L and Performance Status

YTD (2019)

Realized Net Profit from Spreads: -$1,019.40
Spreads started: 71
Realized ROC (target = 72% for the year): -26%

A little caveat to the dismal P&L shown above. Throughout this year, I made a lot of rookie mistakes, and I’m still paying the price. It’s going to take a couple of months to recoup. But I do feel I have improved my trading understanding to fair better.

Last Month (Sept)

Realized Profit: $31.30
Spreads Started: 7 (7 Spreads closed)
Realized ROC (target = 6.0%): 1.62%

Spread Trades Won: 4
Spread Trades Lost: 3

Month to Date (Oct)

Realized Profit: $38.5
Spreads Started: 10 (1 Spreads closed)
Current at risk $$$ for Spreads (original Max: $3,960): 3,303 (83% of max risk)
Realized ROC (original target = 6.0%): 8.4%

Spread Trades Won: 2
Spread Trades Lost: 0
Win/Loss Ratio: 100%

Schedule for this Week

Goals for Week:

• Max technical dollars at risk = $1,000
• Coordinate traded expiration dates to have a blend of Call/Put Credit Spreads
  • Minimize actual dollars at risk for any given expiration date.
• No more than one trade per day – except Friday (catch up day).

Monday:

• Review and tweak the Trend-Channels for the general market direction.
• Determine if the IV is high or low so I can better choose Debit or Credit spreads.
• Review and tweak Trend-Channels for all stocks in the watch list.
• Confirm that the target expiration date for all options trades is set as follows:
  • Bull Call Credit Spreads: Nov 22 (4-weeks).
  • Bull Put Credit Spreads: Nov 29 (6-weeks).
• By 10 AM, stage possible trades for all watch list stocks (but don’t trade anything).
• Watch 1 Webcast or take one online mini-course to be completed by Friday.  

Tuesday – Thursday:

• Review how yesterday’s staged trades moved. Adjust premiums to take advantage of movement as “long-shots”). 
• Submit a couple of Spreads, but keep a close watch. If one takes, cancel the others (we just want one new active trade). 
  • Look at past trades with the same expiration date.
  • Balance the spread strategy (Call/Put) to minimize actual risk for that expiration date.
• Update trading log file and journal (this blog) with any accepted trades.

Friday:

• Review the total technical dollars at risk for this week. If significantly below $1,000 then submit additional spreads.
• Update and post weekly journal (this blog) with any lessons learned or strategy changes.

Trades Ended This Week

DIA: 252.5p/247.5p – 1 Contract – Open 9/25 – Expires 11/01 – Credit = $44.05
(Vertical Bull Put Credit Spread)
Open: Prob. OTM = 83.6%, ROC = 9.6%, Max Risk = $444.05, Max Gain = $50.00
Now Probability OTM = 99.3%

I received a “sell signal” 10/25. As of this morning as I have reached 90% of my Max Gain, and according to rules, I should close. This action will take this risk off the table seven days early.

Closing Cost: $2.00 (.02 premium * 100 shares)
Net Profit: $42.05 ($44.05 credit received – $2.00 closing cost)

Trades Still Cooking

SPY: 308c/313c – 1 Contract – Open 10/11 – Expires 11/01 – Credit = $27.00
(Vertical Bull Call Credit Spread)
Open: Prob. OTM = 93.0%, ROC = 5.7%, Max Risk = $471.00, Max Gain = $28
Now Probability OTM = 95.8%

QQQ: 201c/206c – 1 Contract – Open 10/11 – Expires 11/01 – Credit = $22.00
(Vertical Bull Call Credit Spread)
Open: Prob. OTM = 93.7%, ROC = 4.6%, Max Risk = $476.00, Max Gain = $23
Now Probability OTM = 96.1%

DIA: 277c/283 – 1 Contract – Open 10/9 – Expires 11/15 – Credit = $42.00
(Vertical Bull Call Credit Spread)
Open: Prob. OTM = 80.7%, ROC = 9.2%, Max Risk = $456.00, Max Gain = $42.00
Now Probability OTM = 87.4%

DIA: 259p/255p – 1 Contract – Open 10/15 – Expires 11/8 – Credit = $32.00
(Vertical Bull Put Credit Spread)
Open: Prob. OTM = 83.7%, ROC = 8.7%, Max Risk = $366.00, Max Gain = $33.00
Now Probability OTM = 81.2%

SPY: 287p/283p – 1 Contract – Open 10/15 – Expires 11/8 – Credit = $33.00
(Vertical Bull Put Credit Spread)
Open: Prob. OTM = 83.8%, ROC = 9.0%, Max Risk = $365.00, Max Gain = $34.00
Now Probability OTM = 84.0%

IWM: 160c/162c – 1 Contract – Open 10/17 – Expires 11/15 – Credit = $19.00
(Vertical Bull Call Credit Spread)
Open: Prob. OTM = 87.4%, ROC = 10.6%, Max Risk = $179.00, Max Gain = $20.00
Now Probability OTM = 89.1%

New Trades for This Week

Spreads started this week: 4 (2 Bull Put Credit, 2 Bull Call Credit)
Potential week’s profit: $102.00
Technical dollars put at risk (max= $1,000): $990.00 (ROR: 10.3%)
Actual dollars at risk: $270 (ROR: 37.7%)

SPY: 285p/281p – 1 Contract – Open 10/22 – Expires 11/29 – Credit = $38.00
(Vertical Bull Put Credit Spread)
Open: Prob. OTM = 81.6%, ROR = 10.6%, Max Risk = $360.00
Now Probability OTM = 82.3%

For this Vertical Spread, the current SPY’s price is above the 9-day SMA, which is above the 50-day SMA, which is above the 200-day SMA. The 4-month trend channel is tilting up by about $3.50 per month. So the trend is definitely in an upswing.

The selected strike price is over one standard deviation below the current price, the Return on Risk is higher than 7.5%, and the probability of expiring OTM is over 80%.

Since the ETF SPY aims to track the Standard & Poor’s 500 Index, the S&P will have to drop 150 points within the next 37 days. A mini-correction of 150 or more points on the S&P has happened twice this year already, primarily on the adverse reports from the US/China trade front.

The new dynamic with this trade is the scheduling of the expiration date to near 6-weeks out, instead of the usual 4-weeks. I’m rationalizing that the extended time frame will put this trade in a better position to recover from a mini-correction if one occurs.

QQQ: 202c/204c – 1 Contract – Open 10/24 – Expires 11/22 – Credit = $19.00
(Vertical Bull Call Credit Spread)
Open: Prob. OTM = 88.4%, ROR = 10.6%, Max Risk = $179.00
Now Probability OTM = 88.3%

The short strike ($202) for this position is $1.00 below the standard deviation of $201.05. It is also $2.00 above the top of the trend channel.

Because the QQQ ETF is trending up, I wanted to select a short strike price that had near 90% probably of OTM. The probability is higher than what I would accept for a put spread where the trend is moving away from the short strike.

SPY: 311c/313c – 1 Contract – Open 10/24 – Expires 11/22 – Credit = $17.00
(Vertical Bull Call Credit Spread)
Open: Prob. OTM = 89.3%, ROR = 9.04%, Max Risk = $181.00
Now Probability OTM = 89.6%

The characteristics of this trade is the same as QQQ above.

DIA: 259p/256p – 1 Contract – Open 10/25 – Expires 11/22 – Credit = $28.00
(Vertical Bull Put Credit Spread)
Open: Prob. OTM = 82.9%, ROR = 10.4%, Max Risk = $270.00
Now Probability OTM = 83.1%

The short strike of $259 is both below the 1-SD from the current price and below the trend channel. The 9-day and 50-day SMA are on the rise confirming an upward trend for this ETF.

Additionally, of the two other positions that are scheduled to expire 11/22, both were Call Spreads. Adding this Put Spread to the 11/22 expiration changes that week’s actual dollar risk from $360 to $90, without going over the $1,000 technical dollar risk for this week.

Epilogue

As I made the four spread trades this week, I wanted to focus on the timing and actual risk.

For timing:

I am considering setting a default expiration date for Vertical Spreads that is trending away from the short strike price (IE. a Vertical Bull Put Credit Spread) to be six weeks out. My rationale is that since the market is naturally trending up, and should there be a significant downturn, then there is more time to recover from a loss.

Likewise, I’ll set the default expiration date for those spreads that are trending towards the short strike price (IE. a Vertical Bull Call Credit Spread) to be four or fewer weeks out. Here I think that I want not to give the Market too much time to reach ITM.

For Actual Risk:

If I have a Vertical Bull Put Credit Spread and a Vertical Bull Call Credit Spread, both traded with deep OTM probabilities, and both are expiring on the same day, then the dollars at risk for both positions will cancel each other out. Therefore, I need to coordinate a balance between Calls and Puts spreads to expire the same week.

Therefore, for any given week, and before I submit the first trade, I need to look back in my logs to see what other positions are set to expire that same day then select a Call or Put strategy accordingly.

Cheers…