[Options] When It's Tough Picking Direction, Why Choose at All?

Sean McLaughlin
October 12, 2022

Look, we're not going to sugarcoat it: it's hard out there right now.

Regardless of your timeframe, if you're trying to make aggressive long or short bets in this tape, you're getting chopped up. So are we.

These types of markets grind us out and wear us out. It is what it is. We can't choose the market we're given, we can only control how we react to it.

This much we know -- forcing directional bets right now feels like a fool's errand.

But with options premiums elevated across the board, there are opportunities to put on delta-neutral short premium trades where charts suggest some consolidation may be taking place. However, we need to be careful not to sell premium on stocks that have earnings releases coming up soon. So to avoid that all together, we're going to limit our universe to index and sector ETFs.

The chart the team agrees on most for sideways action right now is this one in the Healthcare sector ETF $XLV:

Thanks to high options premiums, we can sell November options pretty comfortably far away from current price action and earn a nice premium to do so. So we're going to express our neutral bet with a short strangle.

Here's the Play:

I like selling a $XLV Nov 115/130 strangle for an approximately $2.50 net credit. This means we'll be naked short equal amounts of both the 115 puts and the 130 calls:

This $2.50 credit we earn today will represent the absolute most we profit in this trade if we held it all the way until November expiration. But we won't be doing that if we can help it. We'll look to close this spread down for a profit if/when we can do so for half of the premium we collected today -- so at a $1.25 debit. My best practice on short strangles is to close them down when I've earned 50% of the maximum possible profit. Squeezing out those last nickels and dimes are not good risk/reward moves in my book.

Meanwhile, since we are exposed to theoretically unlimited risk here, we need to be vigilant and take action if $XLV starts busting out of its current range. As such, we'll key off the June lows around $118 and our short calls strike of $130 as our risk management levels. Any $XLV close below $118 or above $130 is our signal to get out and take our likely loss (it's possible it might still be a profitable trade for us at that point, depending on the timing). In this tape, we will not hope or pray that the position comes back. If our levels our breached, we're out. No questions asked.

If you have any questions on this trade, please send them here.

ASO subscribers who missed last week’s live video Jam Session where we review activity in our options portfolio from the past week can catch it here.

~ @chicagosean

P.S. We do trades like this regularly. If you'd like to leverage Best-in-Class technical analysis into smarter directional options trades, try out All Star Options Risk Free! Or give us a call to learn more: 323-421-7991.

Filed Under: