Abbott Laboratories is showing an implied volatility percentile of 99%, which means the current level of IV is higher than 99% 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.
Part of the reason for the high volatility in ABT stock is because the company reports earnings on Wednesday before the market open.
Option traders can take advantage of the high volatility by selling a strangle. This option trading strategy involves selling an out-of-the-money put and an out-of-the-money call with the same expiration date.
A 'Naked' Option Trade
This trade generates a premium for the option seller, but it does come with risks. A short strangle is an unprotected trade, sometimes referred to as a "naked" trade. Naked options can be risky as they expose the trader to potentially unlimited losses if the stock makes a big move.
However, if the trader is right and the stock trades sideways, solid gains are possible.
Assuming a trader believes that ABT stock will trade sideways over earnings, they could look to sell an Oct. 20, 85-strike put and an Oct. 20, 95-strike call.
The 85 put can be sold for around $0.55 and the 95 call could be sold for around $0.80.
Selling those two options would generate a total of $135 in premium. That is the maximum possible gain on the trade if ABT stock closes between 85 and 95 on the day of expiration.
To work out the break-even price of the trade, subtract the premium received from the put strike price and add it the premium to the call strike price.
That gives us break-even prices of 83.65 and 96.35.
Implied Volatility Impact On Trade
This is a short vega trade, which means if implied volatility increases early in the trade, losses could occur.
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.
Abbott Laboratories stock has stayed within the expected range following three of the last six earnings reports.
According to the IBD Stock Checkup, ABT stock is ranked No. 6 in its industry group and has a Composite Rating of 62, an EPS Rating of 63 and a Relative Strength Rating of 28.
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
