Most of the trades we've looked at recently will benefit when implied volatility drops or remains low.
When volatility is low, it's a good idea to add some trades that will benefit when implied volatility rises.
One way to find potential trade candidates is to look at the implied volatility percentile of a stock. This measures where the current level of implied volatility sits compared to all readings in the last 12 months.
An implied volatility percentile of 0% means that the current level of implied volatility is the lowest level seen in the last 12 months.
Amgen is currently showing an implied volatility percentile of 11%. That could mean it's a good time to be a buyer of options in Amgen stock.
We can do this via a strategy called a long strangle, which is constructed through buying an out-of-the-money call and out-of-the-money put.
Buying options can be expensive, and they will also suffer from time decay, meaning that they will lose a little bit of value with each day that passes if the stock doesn't make a big move.
Time Decay Affects Option Strategy
With a long strangle, the further out in time the trade is placed, the slower the time decay. But the options are more expensive and require more capital.
I usually go out about three to six months for long strangles and then look to close the trade halfway through if the profit target or stop loss have not been hit. This helps to minimize the time decay, which gets more severe the closer the trade gets to expiration.
A long strangle could be placed for Amgen stock by buying a January 230 strike put and 260 strike call. The call was trading yesterday around $7.50, and the put around $7.90.
When we add the two together, the total cost of the trade would be around $15.40 per contract or $1,540. This is the total amount of risk in the trade and the maximum that could be lost.
The break-even prices are calculated by taking the strike price plus and minus the cost of the strangle.
That gives us break-even prices of 214.60 and 276.40, but profits can be made with a smaller move if the move comes earlier in the trade.
Change In Amgen Stock Volatility Will Impact Trade
For example, the estimated break-even prices at the end of September are 227 and 262.
Changes to implied volatility will significantly impact this trade and the interim break-even prices, so it's important to have a solid understanding of volatility before placing a trade like this.
The worst-case scenario with this Amgen long strangle would be a stable stock price that would see the call and put slowly lose value each day. For a long strangle, I usually set a stop loss at around 20% of capital at risk, which would be around $310.
I also wouldn't hold this trade for more than four to five weeks.
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
