Hey guys, just as promised, I wanted to outline how I made a play on Intuitive Surgical. There was so much uncertainty surrounding the company heading into earnings. I knew there was going to be a huge move, but I didn’t know which way. So, instead of guessing if it will go up or go down, why not do both! That’s right, I bought both calls and puts on this move, which is called a “strangle.” This trade gave me a net gain over 100%!
The key to this trade is a huge move in stock price. If you trade options, you know that you pay a premium on the strike price. If the stock rises well above that call strike price or well below that put strike price, you then can turn around and sell the option at a much much larger premium. So the strategy of this strangle is to find the a put and call strike that will at the very least double if the stock moves in that direction. So the risk here is that the stock MUST, I repeat, MUST move a huge amount… If it doesn’t you will take a hit on both the call and the strike. Ouch. So the worst case scenario here is that the stock doesn’t move at all.
Now let’s get specific. The first question we must ask is does ISRG have the potential to move a lot in stock price? The answer to me was a definite yes. Take a look at the 6-month chart:
Finding a range for where the stock price would go was a little easier than usual. If ISRG had blow out quarters, I estimated that the stock price would have a good chance of topping $115.00, which appeared to be the most likely support (see chart). If ISRG had a bad quarter my guess would that the stock would sink even lower than the last support at $90.00 which happened last quarter. That’s a $25.00 spread in price! So the answer is “yes this stock will move after earnings.” So now we have to find two optimal strike prices that will give us a huge return on the move. We buy put options out of the money far enough to at least double, and we buy call options out of the money far enough to at least double. This part was a little more difficult since it required more math. Click here for my calculations.
There are a few things to know about my calculations. First I needed to calculate BE, which is break even point. The BE is how far the stock must go to reach the strike price + premium paid. Notice how I chose $115 strike price, but I calculated the target move of stock price (a.k.a. “delta”) to actually be $119.00. This is a very important step that many option-traders overlook! You should always factor in the premium when predicting price move. So, when I picked the $115 strike price, I was really thinking “the stock will move to $119.00.” (Please use this Break-Even conservative approach when trading options! Do not rely soley on the “Strike Delta” column, which does not take into account “premium”)
I then converted this move into percentages, which is a little easier to see. Next, do everything all over again, but this time with put options.
So, as you can see, the two optimal strike prices I chose was a $115.00 call and a $95.00 put. Finally, a strangle was made!! The stock price had to move either 15% up or 15% down for me to lock in a gain. Actually, the stock moved 23% the next day, so there was a nice gain. Click here to see the change in option premiums…. wow!!
Now you see how the strangle works? Basically I had a -100% loss on my put option, but I don’t care! I had a 200% gain on my call option! That leaves me with a net gain of 100%!! Monkey time.
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