The Option Trade to Make on Range-Bound Stocks

09/03/2010 12:01 am EST


Joseph Hargett

Financial Analyst, Schaeffer's Investment Research, Inc.

Are Human Genome Sciences Inc. (HGSI) shares caught in a trading range? At least one options trader thinks so. A “short strangle” is one way to play a stock a trader believes will be range-bound for a specific period of time.

Figure 1

On Thursday, a block of 3,859 September 29 puts traded at 10:23 am ET on the New York Stock Exchange (NYSE) for the bid price of $0.55, or $55 per contract. At the same time, a block of 3,859 September 31 calls crossed the tape for the bid price of $0.50, or $50 per contract. With both blocks marked "spread," it is likely that we are looking at the initiation of a short strangle on HGSI.

The trade breaks down like this: the trader receives a net credit of $1.05, or $105 per contract, for selling both the September 31 call and 29 put. However, he will only be able to keep the entire premium if HGSI closes between the $29 and $30 levels when September options expire on the 17th.

Figure 2

There is a little leeway, though, as the breakeven points for the trade rest at $32.05 on the upside and $27.95 on the downside. Any close outside of these breakeven points results in a loss on the trade. What's more, these losses could be potentially extreme, as there is no limit to how high HGSI can rally under the right circumstances.

By Joseph Hargett, contributor, Schaeffer’s Trading Floor Blog
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