Trade scenarios

Posted by Scriptaty | 8:31 PM

Weekly options are useful in several types of trading situations. First, say you recognize the Swiss franc (SF) has been in a trading range for the first three weeks of November, and the fourth week of November does not have any major economic releases likely to move the market out of this range. In such a situation, you might want to sell a strangle in fourth-week expiring options.

A short strangle consists of selling a call option with a strike price at the high end of the most recent week’s range and selling a put with a strike price at the low end of the range with the expectation the market will remain between those price levels until expiration. Selling “naked” premium this way can be very risky, but for experienced traders who can monitor the market very closely and whose research indicates a positive probability for the expected low-volatility price action, the risk is manageable. If the
market remains within the range and the options expire worthless, you keep the premium you collected from the short options.

If you established the short strangle using comparable monthly options, you would collect more premium (because these options are further from expiration and have more time value). However, these options would notdecay as fast as the weekly options because they have more time value than the weekly options.

A long strangle could be used if you think a currency might make a significant price move during a particular week. For example, say the Canadian dollar (CD) has also been in a trading range for the first three weeks of November, but you think economic numbers published in the fourth week of November could really move the currency. You’re not bullish or bearish, but you believe these numbers are going to cause the Canadian dollar to break out of this range. In this case, you could buy a fourth-week expiring strangle, buying calls at the top end of the third week’s range and buying puts at the bottom end of the range.

The risk on a long strangle is limited to the purchase price of the options, plus commissions and fees. (However, if one of the options expires in the money, you can end up holding a long or a short futures position, which would leave you with unlimited risk.) The third trade scenario is based on the idea the Canadian dollar will break out of its range to the downside during the fourth week of November, except that you’re already long Canadian dollar futures. In this situation, you could sell fourth-week Canadian dollar call options to hedge the futures position.