3M) stock is showing an implied volatility percentile of 94%, which means the current level of IV is higher than 94% of all other occurrences in the last 12 months.
When volatility is high, it can be a good time to be an option seller rather than a buyer.
Today we're looking at a short straddle trade. This option trading strategy involves selling an at-the-money put and an at-the-money call with the same strike price with the same expiration date.
This trade generates a large amount of premium for the option seller, but it does come with risks. A short straddle is an unprotected trade, sometimes referred to as a "naked" trade. Naked options can be risky because they expose the trader to potentially unlimited losses if the stock makes a big move.
Risky Trade, But Payoff Can Be Big
However, if the trader is right and the stock trades sideways, large gains are also possible.
Assuming a trader believes that 3M stock will trade sideways over the next few weeks, they could look to sell a Sept. 30, 120 put and a Sept. 30, 120 call.
On Friday, the 120 put could be sold for around $3.35 and the 120 call could be sold for around $5.20.
Selling those two options would generate a total of $855 in premium. That is the maximum possible gain on the trade if 3M stock closes right at 120 on the day of expiration.
To work out the break-even price of the trade, take the strike price of 120 plus and minus the total premium received of $8.55, which gives you 111.45 and 128.55.
If the stock falls below 111.45 or climbs above 208.55, the trade would start to suffer losses.
3M Stock Straddle Risk From Increase In Volatility
This trade is a short Vega trade, which means if implied volatility increases early in the trade, losses could occur.
Short straddles are an advanced option strategy, so if all that sounds confusing, it's best not to trade them.
With a trade like this the potential losses are unlimited and a lot higher than the potential gains, so traders would want to be very confident that the stock is going to remain flat over the course of the trade.
According to the IBD Stock Checkup, 3M stock is ranked No. 21 in its group and has a Composite Rating of 21, an EPS Rating of 55 and a Relative Strength Rating of 23. The stock slid below its 50-day moving average Aug. 26 and has not recovered.
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
