Support & Resistance with Straddles

Hi everyone. I recently received this email which I thought was worth sharing. “Hi Guy, I have another question. I had a trade on GE the other day (58% profit in one day straddle and strangle). I bought GE because of all the usual suspects (cheap, volatile, tiny bid/ask) but the thing that convinced me was the fact that the breakevens fell well within the high low range of recent months. With most of the options I’ve looked at, even when they’re cheap, they require a break through of quite long term support or resistance. So this has become one of my vetting strategies… ie checking if the breakevens fall within the high/low range of recent months. The question is… is this a good idea i.e. does it increase the probability of a profit, or did i just get lucky with GE? …and will I be missing out on too many other trades because I’m being anal about breakevens relative to range?”

 Here’s my answer:

Yes, it is a very good idea and uses a lot of common sense. 

However, remember, we never hold on toexpiration anyway, so using the expiration breakevens is a bit of a redherring, but it’s certainly a conservative, and therefore safer (intheory), way to do it, so definitely well done!

The problem most traders have is thatthey’re not anal enough and they’re too trigger happy.  It’s definitelya bit more difficult now that Implied Volatilties are higher than theywere this time last year, but there are still opportunities and theflags work great all year round provided you’re fussy with those too.


The new Implied Volatility filters we have in development are going toadd a seriously useful dimension to all this … Hopefully will bereleased in time for the next earnings season.

 

In the DGX example on the CD-ROMs I go through a straddleopportunity where the stock was sitting right on a double bottom andthere was a potential 5-point move that we could take advantage of. 

DGX Double Bottom.jpg

 The net result was profitable and then we went through how the ITM$45 strike price turned out to be the better trade as the stock pricerose from around $49 to $54, meaning the ITM calls won the day, givingus a better profit than if we’d traded the $50 strike calls. 

As I write, I want to add that there have been more good flag opportunities recently and I’ll post a few up shortly. 

All the best

Guy

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