by John Kmiecik | December 9, 2013 8:56 am
Are you absolutely torn about where you think a stock is going to head next? Usually, that’s a good reason to leave the stock alone. However, with options, you actually gain a way to confront a stock with an indecisive outlook. Here is a trade idea on Groupon (GRPN) that can profit from several different outcomes in GRPN stock.
The trade: Buy the GRPN April 9 call and the April 9 put for $2.95 or less.
The strategy: A straddle is when you buy a call and a put with the same expiration and the same strike price. Both options are usually close to being at-the-money. Straddles are volatility spreads, so when you buy a straddle, you do so expecting either a big move up or down. In effect, a straddle trader has an opinion about volatility, just not the direction.
The maximum profit on a straddle is theoretically unlimited because the stock can continue to rise forever and pretty much fall to zero. The maximum loss for this GRPN stock trade is $2.95, or whatever was paid for the straddle if Groupon finishes at $9 at April expiration. Both options would expire worthless. Breakeven on this GRPN stock trade is $11.95 ($9 + $2.95) to the upside and $6.05 ($9 – $2.95) to the downside based on a $2.95 cost on these GRPN stock options.
The rationale: Groupon had a very good four-day weekend to kick off the holiday season. The local daily deal and discounted goods site saw sales rise nearly 30% as compared to last year. In fact, it was biggest four-day period ever for GRPN. A good portion of the sales came from selling their discounted goods, which may be critical for the company’s long-term success. But then again, who knows how long that success will last and how long the daily deals model will continue to work?
I cannot speak for others but I personally have not bought a “Groupon” in quite some time. Could it be people have had their fill, or am I just the anomaly?
Click to Enlarge That is why a straddle makes sense in this case. Currently, GRPN stock is sitting on top of a $9 support area, so we’re just looking for a move in either direction to profit.
When buying options, a low implied volatility is preferable, as that generally helps keep options prices low, but GRPN’s implied volatility is only around the middle of its range.
However, with expected volatility events ahead like U.S. budget negotiations, the implied volatility of GRPN stock might increase, and that would increase the option premiums. In addition, another earnings announcement is expected before expiration — that could increase IV as well, though I don’t recommend holding this trade over earnings.
So even though IV isn’t particularly low now, the chance that it could increase in coming weeks still is good for anyone taking this straddle position on Groupon shares.
As of this writing, John Kmiecik did not hold a position in any of the aforementioned securities. Get a free trial of John’s live options trading room here.
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