[Options Premium] Which Way XLK?
As everybody knows, we're still pretty bullish around here and we think this pattern in $XLK ultimately resolves higher:
However, we aren't rigid in our beliefs and are prepared to change our minds when the facts change. And since we're open to the idea that maybe the market is ready for a fall, we have in mind we'd like to position ourselves to participate in either direction. And thanks to low volatilities, this allows us to do exactly that with an attractively priced long straddle position.
Here's the Play:
We're going to purchase a January 75-strike straddle, which means we're going to be buyers of an equal amount of January 75 calls and puts. The price of this spread is yet to be determined. Strangely, at the time of this writing (Thursday evening), the closing prices of the available bids and asks are extremely far apart, making it hard to determine the true value of these options. But that's ok and we won't let that scare us. We'll simply engage in a bit of "price discovery" after the market opens for trading tomorrow. In situations like this, it pays to be patient and work low bids for this trade, slowly improving our price until we can execute a fair fill, or at least until the spreads narrow to something more reasonable. With the amount of open interest in these January 75 calls, I'm confident we'll get executed at a fair price once we find it. I'll likely start my bid for this spread very low -- at around $2.50 -- and improve my bid a nickel or a quarter at a time until I find a fill. (Note: I'll post an update to the bottom of this post with fills that we got as soon as we get them).
Whatever we end up paying for this spread, that debit will represent the most we can lose on this trade. And that max loss is suffered only in the unlikely event $XLK pins $75 at expiration.
If $XLK breaks higher out of this developing triangle (see above), then our price target is in the $84 area and this is where we will begin to trim our position and take profits.
If $XLK breaks lower, we're likely to have two things going for us: 1) A directional move at least to $70, and likely to around $68 which represents this summer's support level, and 2) Volatility priced into these options will likely expand helping to boost open profits. The plan here will be to begin trimming the position (taking profits) when $XLK trades to or through $68.
If neither of these scenarios play out by the time we get into January, then we'll look to exit the trade during that first week of January as we'll be starting to see a significant increase in the rate of decay of our open options premium. We'll sell for whatever we can get (win or lose) and look to redeploy capital elsewhere.
If you have any questions about this trade, or straddles in general, feel free to email me here.
9:50ET am (9/28) UPDATE: we're getting fills in the $5.35-$5.40 range