So this is how they work...

Both the call and put must have the same expiration. It is also possible to write a straddle or strangle, but if you do that, both positions are naked... not for the faint of heart! Here is how each looks:

Straddle: Stock  $20.00   Strangle: Stock $20.00     CALL AUG  20 Cost: $1.10   CALL AUG  22.50  Cost: $0.75   PUT AUG  20 Cost: $1.05   PUT AUG  17.50 Cost: $0.70

You profit from a straddle or strangle when - and only if - the stock moves enough to put the position in the money. For example, when the stock is $20, you buy the 20 Call for $1.10 and the 20 Put for $1.05, both of which are conveniently at the money. Remember, this is not a covered position, so your only cash outlay is $2.15 to buy the call and put to establish the straddle. Suppose that prior to expiration the stock gaps to $26, what happens? The answer is that you are in luck, cowboy! The 20 Call is now in the money $6 and the premium for it now will be that much or more, so you can sell the call for a profit of at least $5. What about the 20 Put? Well, the gap up gutted the put, didn't it? Nobody wants to put stock at $20 when it brings $26 on the open market. Therefore, the value of the 20 Put has fallen. The $1.05 premium you paid for the put now is about $0.40, and you stick another $0.65 profit in your jeans when you buy back the 20 Put. This is a total profit of at least $5.65, more than 2.5 times your original $2.15 investment. The strangle would requires that the stock move more to make the position profitable, but costs less to establish, since both options are out of the money. Yo' money, yo' choice. If you get a small move or no move before expiration, you're out of luck on the straddle or strangle.

This writer then went on to say that, if one side of the straddle made you money, then duuuhhhh, wouldn't it have been smarter to just have taken that side? That is impeccable logic, except how would you (could you) have known which side to buy or write? Ouiji board? Coin flip? Call Martha Stewart?

The Magic of the HVE!

The writer had a point, though. Writing a straddle or strangle is dangerous if you don't have an edge. And here is the edge: the high-volatility event (HVE), such as FDA approval hearings and resolution of major lawsuits and FTC actions. HVEs are too dangerous for you to take one side of them, but perfect for the straddle or strangle. Taking one side is to buy or write either call or put options, but not both. The reason one-sided positions are dangerous is that you cannot know which way the HVE will be resolved and thus cannot know which way the stock will move. For example, the stock can gap up or down hard depending on whether the FDA approves the drug application or not. In fact, when the FDA disapproves a drug application, the stock typically gaps down dramatically and trading will be halted in the stock. Then when trading resumes the next day, it can open quite down. Put differently, taking one side of a HVE is guessing - - save it for Vegas. In fact, a covered write is the single most dangerous position you can take on a HVE, so don't ever write a covered call or covered put on one.

Which brings us to how you make money on a promising HVE. The fact that a HVE is impending results in volatility in the stock. Volatility always presents a chance to make money. And the HVE always presents a textbook case of volatility. If you want to get in on HVEs with a chance to make a profit no matter how the event resolves, instead or buying or writing one side of the event, you have to create a straddle or strangle. A large gap either way makes you money on a straddle or strangle. However, you lose money on a straddle or strangle if the HVE does not occur, is inconclusive or if the stock simply doesn't gap enough. The more significant the event, the greater the potential volatility.

According to a noted options expert, the single best HVE play of all (statistically speaking, based upon research over several years) is the FDA hearing. The date of an FDA hearing is known, or findable, these hearings are only infrequently postponed and are announced in press releases by the companies undergoing the hearings. The FDA events provide the greatest volatility and, historically, the largest price moves of all HVEs. Obviously, the more significant the drug or medical device application is to the company's fortunes, the bigger the pop from the FDA's decision. This is why there frequently isn't a huge movement when the company has many successful products on the market and has revenues in the billions. There also won't be a huge movement if the hearing relates to a modification of an existing drug or medical device, only for those relating to new applications. Finally, you don't want to set up the straddle or strangle more than 3 trading days prior to the hearing. Don't tie up your money any longer than necessary.

You may be wondering how to find these FDA events, since the FDA website (www.fda.gov) does not seem have a calendar of upcoming hearings for new drug and new medical device applications. Here's how we do it: we simply keep an eye on CallWriter's Real Time Lists™ - which present the highest-returning call options. These lists are loaded with potentially volatile stocks. After all, these options hit the Real Time Lists™ because of high premiums, and high premiums imply high volatility. Drug, biotech and medical device stocks with impending FDA hearings tend to show up on one or more of these lists a few days before the hearing date. We simply check news on such stocks appearing on the lists looking for confirmation that an important hearing is upcoming in a few days.. Are there other ways to find companies with impending FDA hearings? There probably are many ways, but the key to making money is volatility, not an upcoming hearing. They are called High—Volatility Events, remember? The high volatility implied by the (relatively) high call premiums is what puts them on the Real Time Lists™ ... so what better place to look?

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