Walmart is showing a very low implied volatility reading. In fact, the current level of implied volatility (18%) is lower than what we have seen 90% of the time in the last 12 months.
That could mean it's a good time to be a buyer of volatility in Walmart stock.
We can do this via a strategy called a long straddle, which is constructed through buying an at-the-money call and an-at-the-money put.
Buying at-the-money options can be expensive, and they will also suffer from time decay. That means they will lose a little bit of value with each day that passes if the stock doesn't make a big move.
Straddle's Pros And Cons
With a long straddle, the further out in time the trade is placed, the slower the time decay, but the options are more expensive and require more capital.
For Walmart stock, a long straddle could be placed by buying a 145 strike call and put for the March 17 expiration. The call was trading yesterday around $6.65 and the put around $3.
When we add the two together, the total cost of the trade would be around $9.65 per contract, or $965 for block of 100 shares. 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 straddle.
That gives us break-even prices of 135.35 and 154.65, but profits can be made with a smaller move if it comes earlier in the trade.
For example, the estimated break-even prices at the end of January are around 137 and 152.
Implied Volatility Affects Trade
Changes to implied volatility will have a big impact on 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 Walmart stock long straddle would be a stable stock price, which would see the call and put slowly lose value each day.
For a long straddle I usually set a stop loss at around 20% of capital at risk, which would be around $180 and a profit target of around 40%.
Walmart is due to report earnings Feb. 21, and implied volatility is likely to drop after that event.
It's important to 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
