Spotify is currently showing elevated implied volatility, with an I.V. reading of 70%. This compares with a 12-month low of 33% and a 12-month high of 90%.
Traders thinking that volatility might drop while prices stabilize could look at an iron condor for Spotify stock.
When volatility is high, the iron condor can be placed further out-of-the-money, giving the trade a decent chance at success.
Let's look at an example using SPOT stock.
As a reminder, an iron condor is a combination of a bull put spread and a bear call spread.
The idea with the trade is to profit from time decay while expecting that the stock will not move too much in either direction.
First, we take the bull put spread. Using the June 17 expiry, we could sell the 90 put and buy the 85 put. That spread could be sold on Friday for around $0.90.
Then the bear call spread could be placed by selling the 125 call and buying the 130 call. This spread could be sold on Friday for around $0.90.
Trade Generates $180 In Premium
In total, the iron condor will generate around $1.80 in premium.
The profit zone ranges between 83.20 and 126.80. This can calculated by taking the short strikes and adding or subtracting the premium received.
Because both spreads are $5 wide, the maximum risk in the trade is 5-1.80 x 100 = $320.
Therefore, if we take the premium ($180) divided by the maximum risk ($320), this iron condor trade has the potential to return 56%.
If price action stabilizes then iron condors will work well. However, if Spotify stock continues to bounce around, the trade will suffer losses.
One way to set a stop loss for an iron condor is based on the premium received. In this case, we received $180 so could set a stop loss at 1.5 times the premium, or around $270.
According to the IBD Stock Checkup, Spotify stock is ranked No. 5 in its group and has a Composite Rating of 33, an EPS Rating of 65 and a Relative Strength Rating of 14.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
