Goldman Sachs stock has been stuck in a range between 280 and 310 for the past month.
With earnings due next week, 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. That's because 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, large gains are also possible.
Assuming a trader believes that Goldman Sachs stock will trade sideways over the next week, he or she could look to sell a July 22, 290 put and a July 22, 290 call.
Yesterday, the 290 put could be sold for around $7.85 and the 290 call could be sold for around $8.30.
GS Stock Needs To Stay In Price Range
Selling those two options would generate a total of $1,615 in premium. That is the maximum possible gain on the trade if GS stock closes right at 290 on the day of expiration.
To work out the break-even price of the trade, take the strike price of 290 plus and minus the total premium received of $16.15, which gives you 273.85 and 306.15.
If Goldman Sachs stocks falls below 273.85 or rises above 306.15, the trade would start to suffer losses.
This trade is a short vega trade, which means if implied volatility increases early in the trade, losses could occur. At the moment, implied volatility on GS stock is around 37%, which is above average for the last 12 months.
Short straddles are an advanced option strategy, so if all that sounds confusing, it's best not to trade them. Also keep in mind that Goldman Sachs reports earnings Monday.
Losses Can Be Unlimited
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.
Last month, we looked at a GS butterfly trade, which has seen a profit of $410 on risk of only $500.
According to the IBD Stock Checkup, Goldman Sachs stock is ranked No. 7 in its industry group and has a Composite Rating of 41, an EPS Rating of 64 and a Relative Strength Rating of 43.
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
