Not sure what direction the market is going? You are not alone in this conundrum. The nice thing about options is that there are strategies for that dilemma. Here is a trade idea on a company whose stock has been volatile lately and it might continue to be…we’re just not sure if it’s higher or lower.
Expedia (EXPE): Straddle
The trade: Buy the EXPE January 2014 $47 call and the January 2014 $47 put for $9.20 or less.
Click to EnlargeThe 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 at-the-money. 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 $9.20 or whatever was paid for the straddle if EXPE finishes at $47 at the January 2014 expiration. Both options would expire worthless. Breakeven on the trade is $56.20 ($47 + $9.20) to the upside and $37.80 ($47 – $9.20) to the downside based on a cost of $9.20.
The rationale: Expedia is an online travel company that operates all over the globe. The company announced earnings in late July and the results were less than satisfactory, if you measure the results by the share price. The stock dropped from above $64 to below $48 in one day. This trade idea is counting on that volatility to continue into the future.
In addition, the company just entered into a marketing partnership with Travelocity. Maybe that is good or maybe that is bad for Expedia let’s just hope it brings some additional volatility to the stock.
Speaking of volatility, the options are trading at unusually low levels as compared to historical levels. The current 30-day implied volatility is just above 33% and the 30-day historical volatility is close to 98%. This means the options may be cheap compared with historical levels which is a good thing since this trade idea involves both buying a call and put. Plus, if the volatility rises, it will increase the option premium making them more expensive. Expiration is about 140 days away which gives this stock plenty of room to move higher or lower. Let’s book some volatility on Expedia!
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