Cisco Systems is showing an implied volatility percentile of 98%, which means the current level of IV is higher than 98% 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 in CSCO stock. 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.
Trade Offers Risk, But Reward
However, if the trader is right and the stock trades sideways, large gains are also possible.
Assuming a trader believes that CSCO stock will trade sideways over the next few weeks, they could look to sell a Nov. 11 expiry, 42-strike put and a Nov. 11, 42 call.
Wednesday, the 42 put could be sold for around $1.27, and the 42 call could be sold for around $1.25.
Selling those two options would generate a total of $252 in premium. That is the maximum possible gain on the trade if CSCO stock closes right at 42 on the day of expiration.
To work out the break-even price of the trade, take the strike price of 42 plus and minus the total premium received of $2.52. That gives you 39.48 and 44.52.
Below 39.48 and above 44.52 the trade would start to suffer losses.
Higher Implied Volatility Would Hurt Trade
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.
A stop loss could be placed at the break-even points.
According to the IBD Stock Checkup, CSCO stock is ranked No. 7 in its group and has a Composite Rating of 72, an EPS Rating of 70 and a Relative Strength Rating of 45.
The bear call spread trade on Moderna discussed Wednesday in this column has already done very well and could potentially be closed early.
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
