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Friday, October 15, 2010

And the Strangle hit it off the park!

As analyzed on the previous post, yesterday Google moved strongly after earnings report. But let's take a look at it in slow motion:

Thursday, October 14.

3:30 pm, just 30 minutes before market close, it is presumable that Google has made most of its move for the day and everything else will be left for the earnings. At 3:30pm the stock was priced at $538.63.

Earnings to be announced after market close at 4:00pm, this was a good time to enter the game and speculate with a neutral approach. Our thought: Google will move sharply, either up or down. The strategy: We by a Straddle, the simultaneous purchase of a CALL and a PUT at the same strike price, or we buy a Strangle which turns out to be cheaper. Remember if we had used the Straddle we would have purchased the 540 CALL and the 540 PUT. With the Strangle, however, we buy the 530 PUT and the 540 CALL, in other words we surround the stock with a PUT at a strike price below current stock price and a CALL at the strike price above it. Google options have strike prices every ten points, so you have 520 strike price options, 530, 540, 550 etc. The trade looked like this:

BUY 1 OCT GOOG 530 PUT @ 7.90 ($790)
BUY 1 OCT GOOG 540 CALL @ 11.00 ($1100)

Remember that an option gives you the right over 100 shares, so you have to multiply the price of the option by 100.

Earnings are published and turned out to be better than expected sending GOOG up to the sky. Google opens the next day at 599.27!!!! Spectacular!!

Our PUT option of course got crushed down to zero, but our CALL really made some good gains going up to 55.60!!

SELL 1 OCT GOOG 530 PUT @ 0.00 ($0.00)
SELL 1 OCT GOOG 540 CALL @ 55.60 ($5560)

So, we invested $1890, and the next day we got $5560, a nice $3670 profit in just one day. 194% Return on investment.

Now, how could this trade have gone wrong? Well, if Google had moved just by a few points, let's say 10 points either up or down, then probably the winner option wouldn't have gained enough value to offset the loss of the loser option. So when you play either the Straddle or the Strangle you are betting on a huge move, it doesn't matter if it is up or down, you just need the stock to move abruptly, the more it moves the better.

Well I hope you guys understood the lesson and include both the Straddle and the Strangle in your weapons arsenal. Other good movers during earnings are :


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