Options on Canadian e-commerce giant Shopify may currently be undervalued, offering a potential opportunity for investors. Here's how to create an options straddle to bet on a larger-than-expected move in Shopify stock.
A straddle is an options strategy where the investor doesn't take a view on whether the stock will move up or down. Instead, the trader believes Shopify stock will move significantly in either direction, more than the market anticipates.
Placing A Straddle On Shopify Stock
With Shopify trading around 69 a share Monday, investors can consider placing a straddle by buying the 70-strike monthly call option in Shopify stock and 70 put on the Sept. 20 expiry.
This trade can be placed for a debit of $6.80 per share, based on recent trading. It would cost $680 per set of contracts. The figure also coincides with the maximum loss of $680 if the shares trade exactly at 70 on expiration.
In the event of a significant move, the maximum profit on this trade is unlimited. In a best-case scenario, traders could earn multiples of their initial investment.
Shopify stock options for the Sept. 20 expiry currently have an implied volatility of 37%. That's far lower than the 30-day realized volatility of 72%, or even the 90-day realized volatility of 61% on the stock. That could suggest the options are very cheap if Shopify stock continues to move similarly to the past.
Notably, investors should expect lower volatility as Shopify already reported its second-quarter earnings on Aug. 7; which saw the stock soar over 17% after topping expectations and providing an upbeat forecast
Why Increased Volatility Could Drive Further Moves
However, even without an earnings event, heightened market volatility could drive further significant moves in Shopify stock. Over the past 10 years, Shopify shares have never realized a 30-day volatility below 30%. That includes periods of extremely low market volatility with the Cboe Market Volatility Index (VIX) between 10 and 12. Currently, the VIX has fallen back to around 19.
Although this trade is neutral at its inception, once Shopify shares move away from the straddle point, the trade will begin to take a directional bias. If investors anticipate continued momentum, they can hold the trade for the potential of a larger gain. If not, they can close the trade or hedge using shares, thus reinstating a neutral view.
Shopify shares are currently trading between 50- and 200-day lines as the stock forms a double-bottom base. SHOP on Monday experienced upside resistance at the 200-day moving average.
