Strangle - With a Twist

[caption id="" align="alignright" width="185" caption="Image via CrunchBase"][/caption]

Recently, when Netflix (NFLX) reported earnings, the stock fell out of bed.  It dropped like a stone, shaving about $50 off its then price.   That was about a 20% drop in just a few days.  Tonight NFLX is reporting earnings again, and I would like to position myself to profit in any direction the stock might go.  The way to accomplish that is traditionally through what is known as a "Straddle," where one buys and sells a put and a call option with the same strike price and the same expiration date.  With the stock currently at $250 (+/-), a straddle would be buying a $250 strike call and buying a $250 strike put.  The greatest volatility and movement comes from the nearest expiration month, in this case, May 2011.  With earnings coming out tonight, a May 20, 2011 expiration feels right.  But buying a $250 call would cost $16.95, and a $250 put would cost $14.25, for a grand total of $31.20 per share, or $3120.00 for 1 contract of each (each contract controls 100 shares). 

The idea is that by positioning yourself at the same strike price, if the stock falls, the put you bought will increase in price, while the call would decrease in price; while if the stock rallies, the call you bought would increase in price, while your put would decrease in price.  You are looking for a sufficient increase in price to compensate for the entire position cost.

The Strangle is a variation on the straddle.  Whereas the straddle encompasses a call and a put at the same strike price, the strangle is a position with prices that are not the same.  Those prices can be either in the money (ITM) or out of the money (OTM).  The expiration date is the same.

Here is what I did:

Bull Put Spread

I bought to open (BTO) a May $235 put = $8.25

I sold to open (STO) a May $240 put = $10.05

CREDIT $1.80

-and-

Bull Call Spread

I bought to open (BTO) a May $260 call = $11.63

I sold to open (STO) a May $265 call = $9.75

DEBIT $1.88

NET DEBIT $.08 plus commissions

Notice that both are bullish positions: The Bull Call Spread from $260-$265, and the Bull Put Spread from $235-$240.  Both of these spreads are said to be out of the money (OTM) (refer to previous blogs for definition).  If NFLX rallies, the Bull Put Spread will expire worthless, and I will pocket $1.80, and will be able to sell to close (STC) my Bull Call Spread at $5 less my debit of $1.88 for a total gain of $3.12. 

But the main reason I put on those positions is because it costs me very little, and I can modify the legs of either spread should there be a dramatic movement in the stock.