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For the past six weeks, we have been discussing a straddle strategy. We chose to use ExxonMobil (XOM) in a mock trade using a straddle so that we could see how the week-to-week movement in the underlying impacts a straddle trade. We have some keys that we are looking for when trading a straddle, as follows:

1. Find a stock that has low IV compared with historical volatility.
2. Find a stock that has been in a tight trading range.
3. Find a stock that has pending news in the next 4 to 8 weeks.
4. Allow at least 30-days until expiration after the expected news event.
5. Know your breakeven points so that appropriate exit strategies can be set up.

XOM fit this criterion with the stock set to announce earnings on Oct. 29 and the daily chart in a triangle formation. IV was low historically speaking and this is a key when trading a straddle or strangle. We did see some volatility in XOM shares, but the net movement needed to make solid profits never developed, though the mock trade did end with a mild profit if traders exited the session before earnings were announced. Below is the week to week data for this straddle trade:

Sept. 28, 2009
XOM @ 69.59
Buy 1 Jan10 70 call @ 3.10 [IV=22.7]
Buy 1 Jan10 70 put @ 3.95 [IV=23.7]
Max Risk = $705
Max Profit = Unlimited
Downside Breakeven = 62.95
Upside Breakeven = 77.05
Profit Expectation = $350

Oct. 2, 2009
XOM @ 66.58
1 Jan10 70 call @ 2.00 [IV=24.4]
1 Jan10 70 put @ 5.85 [IV=25.7]
Max Risk = $705
Max Profit = Unlimited
Downside Breakeven = 62.95
Upside Breakeven = 77.05
Current Profit = $80

Oct. 9, 2009
XOM @ 69.27
1 Jan10 70 call @ 2.70 [IV=22.1]
1 Jan10 70 put @ 3.90 [IV=23.6]
Max Risk = $705
Max Profit = Unlimited
Downside Breakeven = 62.95
Upside Breakeven = 77.05
Current Profit/ Loss = ($45)

Oct. 16, 2009
XOM @ 73.12
1 Jan10 70 call @ 4.53 [IV=20.3]
1 Jan10 70 put @ 1.84 [IV=21.6]
Max Risk = $705
Max Profit = Unlimited
Downside Breakeven = 62.95
Upside Breakeven = 77.05
Current Profit/Loss = ($68)

Oct. 23, 2009
XOM @ 73.57
1 Jan10 70 call @ 5.18 [IV=23.8]
1 Jan10 70 put @ 2.01 [IV=25.0]
Max Risk = $705
Max Profit = Unlimited
Downside Breakeven = 62.95
Upside Breakeven = 77.05
Current Profit/Loss = $14

Pre-earnings announcement
Oct. 28, 2009
XOM @ 73.84
1 Jan10 70 call @ 5.48 [IV=25.3]
1 Jan10 70 put @ 2.03 [IV=26.7]
Max Risk = $705
Max Profit = Unlimited
Downside Breakeven = 62.95
Upside Breakeven = 77.05
Current Profit/Loss = $46

We did see an increase in IV on XOM options heading into its earnings release. This helped the stock turn profitable despite a move that didn't match our expectations. The data above is using the closing data for XOM on Oct. 28 with XOM announcing earnings before the open on Oct. 29. Intraday on the 28th, XOM shares hits a high of $74.96, so a better profit could have been achieved.

Post-earnings announcement
Oct. 29, 2009
XOM @ 73.96
1 Jan10 70 call @ 5.20 [IV=22.4]
1 Jan10 70 put @ 1.77 [IV=25.1]
Max Risk = $705
Max Profit = Unlimited
Downside Breakeven = 62.95
Upside Breakeven = 77.05
Current Profit/Loss = ($8)

Interestingly, XOM reported disappointing earnings the morning of the 29th, yet the stock added 12-cents on the session. However, the resulting decline in IV left the trade with a loss of $8 compared with the $46 gain seen before the announcement. On Oct. 30, XOM shares fell $2.29 to $71.67, which sent IV higher, yet the trade still would have a loss of $10.

The nice thing about a straddle or strangle is the fact losses can be limited by having proper exit strategies. We didn't quite get what we wanted out of the XOM straddle, yet a mild gain was achieved. If nothing else, I hope readers learned from this mock trade how important implied volatility is to a straddle. This is often overlooked or thrown aside by new traders until they learn the hard way how IV can impact the value of a trade.

We will begin a new strategy next week, so please let me know what strategies you would like to see discussed on my ofrum, which you may access through the homepage at Optionetics.com.

Jody Osborne
Senior Writer & Options Strategist
Optionetics.com ~ Your Options Education Site

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