In last week’s article we kicked off the reporting season by explaining how strangles work and why we use them during reporting season. With reporting season well underway, there are plenty of opportunities to put it into practice.
In a couple of days Wesfarmers Ltd (WES) is reporting. It is currently trading at $54.79.
- Reports in two days (17th of February).
- Risk = Premium: $6,757.83
- Profit target is a 4 – 5% share price movement.
Below is the payoff matrix of the trade above. The Y axis on the left is the share price range and the X axis up the top is the time range. The middle share price of the Y axis is the current share price at $54.79. The numbers above it are 1% share price increases. The numbers below it are 1% share price decreases. The X axis simply shows today’s date and the following seven days. By looking at this matrix we can project into the future and see what our rough profit and loss would be at different times and different share prices. It only shows profit or loss – for example, if the share price rises to $56.98 (4% higher than the current share price) by the 17th of February, then roughly $2,030 profit is made. You would therefore sell your original position for roughly $8,800 ($6,757.83 + 2,030).
Quick matrix takeaways:
- A 5% rise or fall is a good profit (about 15 – 50%) on the day of the report (17th of Feb).
- If the report does nothing, provided we close in the following days we can limit losses (about 10 – 20%).
- The longer we stay in the trade, the less profit is made, and the worse our losses get.
- Breakeven on about a 3% rise or fall.
Although this strategy seems simple enough, the danger is in the detail. Volatility shifts need to be accounted for. There are little adjustments that make an impact that a beginner trader won’t know to do. We suggest you only try this strategy if you already have a strong Options background or have a mentor (like we provide).
If you are interested in learning how to trade these strategies and want a mentor to hold your hand, get in touch by emailing Advisors@traderscircle.com.au or by calling 03 8080 5788