BALLON STRANGLES, A BETTER TRADING STRATEGY
Windowofworld.com – What are ballon strangles in a trading strategy? I have often taught that there is retaliation for anything the market or stock can throw at you. You may not know it but there is one.
This is generally the correct statement because if you wait too long there are some situations you can’t avoid, but for the most part there are ways to respond and survive any fight.
IF YOU KNOW WHAT TO DO AND HOW TO DO IT. The emphasis is on making the difference that knowing is not enough. You have to know how and that takes training. But it starts with knowing what.
I developed the Balloon Strangle as a way to counter the effects of high volatility and uncertainty (eg danger) from news announcements that occur when markets close. This is like income after hours of work or an anticipated Board meeting or court decision. Something that could massively move stocks but you are not sure which way. The conventional wisdom (and this is good advice) is to avoid this like the plague.
The conventional strategy to reduce the effects of volatility is the strangle or straddle game. The traditional positions for strangles and straddle are at or near the money. You take the opposite position so that either way you have a winning position. You hope that the movement is large enough that the losing positions are zero and then the winners can make money. The issue near the money position is expensive and the movement must be large enough to clear one position and still move far enough to make money in another. But the idea is that you are somewhat isolated from the unknown. At least you can survive even when one goes up in value and the other goes down.
The Balloon Strangle is a twist on using leverage from the Out of the Money position. If you use a chart to show option prices, you will often see the leverage point in the curve created by plotting the option price. It happened in the Out of the money position. It represents a place where option values change much faster in one direction than in another. In other words, if the stock moves in one direction, the option value changes very quickly but very slowly if it moves in the other direction.
Here is an example of a Balloon Strangle on an income game with YHOO. I played this because of the potential for YHOO to have to move far enough to make out of the money calls and put pay off fees. The potential is double my money.
Now YHOO is among the important price levels. This is the perfect setting for this drama. YHOO earnings usually have large movements and have clear targets.
Now this is what happened. YHOO moved like following a script. The upward movement is directed towards resistance.
Now the YHOO yield rises to resistance and hesitates. 2 hours entered the trading day and at the next sign of doubt I stopped trading. The resistance seemed to hold, I got what I was looking for in an up move so I sold both positions. The $ 1.75 net amount is very close to the $ 1.70 estimate.
By the way, as the day passed and YHOO made no attempt to move higher, the October 42.50 value started to fall much faster than the stock’s decline in value. It dropped 42.50 calls above 0.50 while the stock pulled back 0.60. Waiting for the end of the day will cost you more than 0.50. The drama is only for capturing reactions to the news.
This strategy takes practice and applies to potentially good-sized moves. Always practice without funds beforehand.