I think it is safe to say that many, if not most, traders have no clue where the market goes from here. As a market participant, that probably does not give you a warm and fuzzy feeling. But what if there was a strategy that can profit if the underlying price moves considerably higher or lower?
That is not a possibility for stock traders because they can be either long or short underlying, not both. Not so with options!
There are quite a few stocks that have had extended runs as of late, like 3M Co (NYSE:MMM) and PepsiCo, Inc. (NYSE:PEP), and now have run into a resistance area from prior pivot highs. There is one, however, that has dropped dramatically (even before announcing earnings) and has continued to fall. That stock is Target Corporation (NYSE:TGT).
Recently, Lawrence Meyers wrote an article on Sears Holdings Corp (NASDAQ:SHLD) and he commented about how he feels many other consumer retail stocks may also be in trouble, including Target. But what if TGT finds support and starts to rally?
Here is a trade idea that may make sense, and it is called a straddle.
TGT Stock Options
The Rationale: Take a look at a five-year chart of TGT just below. The stock has dropped down to a level it has not seen since the beginning of 2014. Target stock has had an extended move lower and now is facing some potential support. Often, equities will reverse off of that support and move higher. But if retail and Target Corp. continue to stay weak, it might just continue to drop, without immediate potential support anywhere near. If it does rally, it does not face any potential resistance up until the $63 area.
Click to Enlarge This trade idea also makes sense from an implied volatility standpoint, too. The implied volatility of the options is well below historical levels, which means options may be underpriced. That is perfect for this trade idea, since both a call and put are purchased.
In addition, if IV increases, the option premiums should increase as well, which could increase the price of the options and generate a potential profit.
The Trade: Buy the July $55 call and the July $55 put for $6.35 or less.
The Strategy: A straddle is when you buy a call and a put at the same strike price. Straddles are volatility spreads. When a straddle is bought, it is done in the expectation of a big move either up or down. In effect, an option trader has an opinion about volatility but not the price. 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 is $6.35, or whatever was paid for the straddle, if TGT finishes exactly at $55 at July expiration. Both options would expire worthless. There are two breakeven points at expiration based on a cost of $6.35; $48.65 to the downside and $61.35 to the upside.
This option trade does not have to be held to expiration to profit or for that matter to lose. Consider managing this trade with a profit goal in mind and a certain amount you are willing to risk. Options are a decaying asset, so options lose value as time passes with all other variables being held constant.
John Kmiecik is the head options instructor for Market Taker Mentoring, and co-author of the eBook 3 Secrets to Making Money in Any Market. Get your complimentary copy of his option trading eBook here. He can be reached at john@markettaker.com. At the time of this writing, he did not own a position in any of the aforementioned securities.
