Straddles can help a trader make money in the most volatile environments
Subscribers to Chart of the Week received this commentary on Sunday, March 12.
Earlier this month, subscribers to our Volatility Trader (VT) service scored an 80% profit on a Pfizer Inc (NYSE:PFE) straddle. Ho-hum, what’s the big deal about an 80% profit? In today’s uncertain market ecosystem, straddles can be a great way to take advantage of any stock movement. You don’t have to nail highs and lows, just movement in general. We brought on Senior Equity Analyst Joseph Hargett to unpack the reasoning behind our winning PFE trade.
“One example of a really good straddle trade is the Pfizer (PFE) March 10, 44-strike put. We entered the trade on Feb. 14 — a straddle on Valentine’s Day, make of that what you will. Because you have to be selective with straddle trades in this market when you’re range bound but have volatility, you need to look for stuff like this. There was this really tight range after the stock came down hard into a basing pattern. In any normal market this would look like a nice rebound level, but in this climate, with all the uncertainty and volatility, do you really want to bet on that? The market could pull the rug out from under you.
We had compressed volatility, with the [Schaeffer’s Volatility Index] SVI at an annual 52-week low. The other concerns were at the $44 strike level that was the peak back in 2018 as well as resistance. It could have provided support, but a break below clearly would have upset some people and indicated selling was in. It was a key pivot point. The 20-day moving average capped Pfizer on the day we entered the trade and was a trendline that stepped up in January.
The backdrop here on the sentiment side is Pfizer appearing on the cover of a Barron’s bullish story back in February. If you’re up on your Expectational Analysis, mainstream media giving flashy bullish or bearish signs on covers is not necessarily the best thing to invest in.
By the time this information hits print or the internet, the story is already known by most of Wall Street. If you’re trading off that, just know the market itself already knows all this information. You come into PFE with peak bullish sentiment in the middle of a decline. Maybe they (Barron’s) were trying to call a bottom. But regardless, now you have retail investors reconsidering this while the rest of us really know what’s going on.
As an aside, if you want to hear more from Joe, check out his most excellent podcast debut below!
Pfizer had a wealth of bullish sentiment and technical drivers that wanted to move. The rest of the market wanted it to move. We threw that straddle on, not knowing which direction it was going to go. It didn’t matter, it just has to ‘go.’ That’s the beauty of the straddle — you don’t need to know the direction.
The stock did exactly what we expected. It broke down below $44, and once that break happened after the rejection of the 20-day, we saw capitulation to the downside. Lingering bulls were squeezed out and the stock dropped.
But, you have to watch these types of trades in this type of market. You can get a sharp downside move that then reverses rather quickly. Pfizer hit the round-number $40 on the 28th and promptly found buying support. That rebound didn’t immediately shake us out but prompted us to take half our profits off the table. We closed half the position for a 100% gain, just to make sure there was no loss on the position. The next day, Pfizer headed lower once again, but support was firm at $40. That was our signal to get out of dodge. We sold the rest on March 3 amid the rebound for an 80% gain.
As you can see, straddles can be very profitable in high volatility markets, when that volatility isn’t being priced in correctly, as it was with PFE.”
Image and article originally from www.schaeffersresearch.com. Read the original article here.