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Is It Time to Buy Straddles?

02/14/2013 8:00 am EST


Lawrence McMillan

Founder & President, McMillan Analysis Corporation

With the VIX flirting with six-year lows, eventually it has to go up, and Larry McMillan of McMillan Analysis Corporation offers a trade idea based on this scenario.

Currently, option implied volatilities are near extreme lows, by many measures. We have seen that VIX got down to nearly 12. It has been below 10 in the past, though, so it is not at historically low levels. However, many stocks have options that have never been cheaper. For example, IBM’s composite implied volatility (VIX) has been hovering near 10 lately. It has never had cheaper options in the nearly 40 years that listed options have been traded on the stock.

Over 50% of all stocks have options that are in the 5th percentile of implied volatility or lower. This includes nearly every large-cap stock there is (except for something like McGraw-Hill (MHP), which is being sued by the Federal Government).

Other potentially volatile stocks that are in the 0th percentile of implied volatility (as IBM is), include SNDK, SOHU, WYNN, CAT, TSN, LCC, MUR, ASH, IR, HUM, RIG, NDAQ, and POT.

It is highly likely that straddle purchases on these stocks will be profitable at some point in the relatively near future. They might not explode right away, but as soon as their volatility begins to increase, it is probable that they will make sizeable moves.

From a timing viewpoint, there is no obvious time to buy straddles. If one buys too early, he loses time decay. If he buys too late, he misses the first part of the move, and the options might be far more expensive. But if you follow any of these stocks, and you think a move is likely, the purchase of a 3-to5-month straddle is a trade with the odds in your favor.

By Lawrence McMillan, Founder and President, McMillan Analysis Corporation

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