Short Strangle on MER, need feedback on this trading

newguy05 · Dec 15, 2007

Hi guys,

I am still learning, have a couple more questions.

1) - Short MERAM (Jan 65 Call)
- Short MERMJ (Jan 50 Put)

I dont think MER will move outside of this range by Feb, the current resistence / support seem to be around 62/55.

My plan is to hold it till both expires. Need feedback on if this is a good idea.

2) Is there a free website that has the most up to date info on the top 20 stock that had the largest short interest increase for the month?

3) Why are there no options for the month of Feb/March? MER has option on Jan, then it skips to Apr.

thanks!

atticus · Dec 15, 2007

Quote from newguy05:

Hi guys,

I am still learning, have a couple more questions.

1) - Short MERAM (Jan 65 Call)
- Short MERMJ (Jan 50 Put)

I dont think MER will move outside of this range by Feb, the current resistence / support seem to be around 62/55.

My plan is to hold it till both expires. Need feedback on if this is a good idea.

2) Is there a free website that has the most up to date info on the top 20 stock that had the largest short interest increase for the month?

3) Why are there no options for the month of Feb/March? MER has option on Jan, then it skips to Apr.

thanks!

Always price the atm straddle to define the implied distribution of the shares to expiration. You're receiving $2.85 to sell the strangle which is neutral delta at $67.80. You're flat to bullish on MER.

Feb will begin trading the Monday after Dec expiration.

newguy05 · Dec 15, 2007

Quote from atticus:

Always price the atm straddle to define the implied distribution of the shares to expiration. You're receiving $2.85 to sell the strangle which is neutral delta at $67.80. You're flat to bullish on MER.

Feb will begin trading the Monday after Dec expiration.

Sorry can you explain more what atm straddle (what does atm stand for?) and implied distribution means? I tried search google but cant find a useful explanation for those 2 terms.

Also if Feb begins trading after Dec expirtation, why is Apr already being traded?

thanks.

-------------------------------------
Here's the p&l chart based on 25 contract for each short.

Profit & Loss Chart at Expiration
Price Profit/Loss
$35.00 ($30,375)
$42.50 ($11,625)
$47.15 $0
$50.00 $7,125
$57.50 $7,125
$65.00 $7,125
$67.85 $0
$72.50 ($11,625)
$80.00 ($30,375)

forex-forex · Dec 15, 2007

Quote from newguy05:

Sorry can you explain more what atm straddle (what does atm stand for?) and implied distribution means? I tried search google but cant find a useful explanation for those 2 terms.

When Googling for information on options use "option" as one of the search words.

ATM = At The Money
option atm

Quote from newguy05:
Short MERAM (Jan 65 Call)
Short MERMJ (Jan 50 Put)
I dont think MER will move outside of this range by Feb, the current resistence / support seem to be around 62/55.
My plan is to hold it till both expires. Need feedback on if this is a good idea.

I think it's a bad idea for a newbie to get involved in this trade. I would consider an Iron Condor instead, buy the Jan 45 Put and Jan 70 Call to go with the short options. The maximum loss is now capped.

RichardRimes · Dec 15, 2007

Quote from newguy05:

Hi guys,

I am still learning, have a couple more questions.

1) - Short MERAM (Jan 65 Call)
- Short MERMJ (Jan 50 Put)

3) Why are there no options for the month of Feb/March? MER has option on Jan, then it skips to Apr.

thanks!

Stocks have a rotation schedule. There are 3 rotation schedules....sooo some stocks have DEC..MAR, JUNE, SEP..others JAN, APR, JUL, OCT and the final group is FEB, MAY, AUG, NOV. ALL stocks have Jan because of the popularity of LEAPS (I think) and the indicies have all months.

As FF mentioned you define (limit) your risk with the iron condor and that may be a better play if you think the stock will trade in a range. It will also lower the margin you need. However you can sell the strangle if the IV (implied volatility) is high compared to the historical volatility...then when the volatility does come down buy the outside strangle to convert to an iron condor and perhaps you'll have an IC at better than fair value. You can also leg into the IC if MER goes up buy the outside put and if it goes down buy the outside call.

Its an old saw but with options you are making (primarily) BOTH a volatility bet as well as directional bet...VEGA/DELTA and hoping that THETA (time) is your friend when you sell.

newguy05 · Dec 16, 2007

thanks guys, i checked out iron condor for MER. But do you really think it's a good idea right now vs just a short strangle?

Contract size: 25

Strangle:

-Short 50 PUT (MERMJ): 1.6
-Short 65 CALL (MERAM) 1.25

Risk:
-MER between 50-65 = max profit
-MER between 47.15-50 OR 65-67.85 = 0 to max profit
-MER >67.85 OR MER <47.15 = loss (unlimited)

Max Profit: 2.75 * 2500 = $7125

Iron Condor:

-Long 45 PUT (MERMI): 0.75
-Short 50 PUT (MERMJ): 1.6
-Short 65 CALL (MERAM): 1.25
-Long 70 CALL (MERAN): 0.50

Risk:
-MER between 50-65 = max profit
-MER between 48.5-50 OR 65-66.50 = 0 to max profit
-MER >66.5 OR MER <48.5 = loss limited to $8750 max

Max Profit: (2.75-1.25) * 2500 = $3750

comparison

Basically i am losing about half the profit to buy a risk protection for when MER falls outside 66.5 or 48.5 price range.

Considering all the good/bad news about MER's new ceo/writedowns are pretty much on the table now and i dont foresee a huge price movement before jan expiration. Is it still a standard practice to use condor over a strangle? I just dont see a big reason to do so.

Also is my logic correct? am i missing any key piece of information in my calculations above?

thank you

forex-forex · Dec 16, 2007

All the above looks OK, you know the risk. I would add an exit plan if MER moves against you and reaches one of the strikes.

Some exit plans.

Buy back the ATM short options when MER reaches $65.00 or $50.00 and keep the OTM short options open.
If it's an Iron Condor you would have to consider liquidating the entire leg that is ATM and leave the OTM leg open.
Hold till expiration regardless of what MER does.

RichardRimes · Dec 16, 2007

Your calculations are fine. Its obvious you are wedded to your conclusion that MER will trade in a range and the volatility is higher than it should be. Soooo you are making a volatility bet...simple as that. If YOU are right and the MM's and the Vols are wrong...you will do very nicely. If your wrong then hopefully you have some of FF's ideas in place.

atticus · Dec 16, 2007

Quote from forex-forex:

All the above looks OK, you know the risk. I would add an exit plan if MER moves against you and reaches one of the strikes.

Some exit plans.

Buy back the ATM short options when MER reaches $65.00 or $50.00 and keep the OTM short options open.

If it's an Iron Condor you would have to consider liquidating the entire leg that is ATM and leave the OTM leg open.

Hold till expiration regardless of what MER does.

Keep the shorts open? Open at a nickel?

forex-forex · Dec 16, 2007

Quote from atticus:

Keep the shorts open? Open at a nickel?

They would be about $15.00 OTM, could close them though and free up margin for the next trade. A nickel would be the last week. This is something that newguy05 would plan beforehand.