Look Both Ways – the series

I have been reviewing my Trading Journal for the month of December and several interesting opportunities present themselves for a LBW (Look Both  Ways) trade setup. My initial post on the LBW strategy focused on the use of a Strangle options trade. For this post, I will lay out a Straddle buy (in the current options month) that is financed with a Put sale (in an out month).

Let’s get to the setup. The candidate for this trade setup is DMND (Diamond Foods). Here is a current Daily chart:

As you can see above, the stock has been on a severe decline since the Doji on 9/21/2011. The recent price action as been more of a bottoming process while investors digest the issue surrounding the company and its payment to Walnut growers (the SEC now has a formal investigation into the matter).

So what is the real opportunity here? The premise behind the LBW strategy is that “A” move is coming but it is not easy to determine what “THE” move is going to be. That being the case, I take the approach that I want to have a bet on both sides – I want to Look Both Ways.

Here is the trade:

1) Sell the March 2012 30 strike PUT for 6.80 (current OI is 658)

2) Buy the Jan 2012 30 strike Straddle (CALL & PUT) for 5.80 (current OI is 3086 combined)

The result is a net credit of 1.00

Here are the exit scenarios:

1) The stock price goes up thus allowing you to take advantage with the Jan 30 Call ownership (sell for value or excercise to obtain the underlying stock). The Put side of the trade will lose value for both the sold & owned put. After January expiration, you will be short the Mar Put and can determine course of action.

2) The stock prices goes down thus allowing you to take advantage with the Jan 30 Put ownership. The Call side of the trade will lose value as you get closer to expiration on Jan 20. If the Jan 30 strike Put remains in the money on Jan 20 then you would want to exercise the option to cover the short Mar 30 Put. You keep the 1.00 credit and any value obtained from selling the Jan 30 call (if any).

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