British Pound (BPJ19): 28 March 2019

[TradingAdmin]

This trade brought to you courtesy of Brexit.  The British Pound is trading at extremely high implied volatility.  The Pound itself is stuck in a trading range for the past four weeks:



Will the general uncertainty continue for another week?

Well, we have a short term opportunity here to make some profits.  The April Options contract expires in 9 days time (two of those days are this Saturday and Sunday, thus only 7 trading days time).  We trade it using  Short Straddle (we sell an ATM Call and Put)



Graph on the right - look at the extreme wide range of prices under which we are capturing the BP - (130.5 - 135.5), well beyond the extremes of the trading range into which the pound finds itself.  Look at the position graph left - because of the high volatility, these options are trading at exorbitant prices, our profit potential is at $1,600 !  For just a 9-day trade.

This will be the profitability line on Monday, this Monday, 1st of April, 4 days into the trade:



We'll be profitable anywhere from 130.5 to about 135.3; maximum profit already sitting above $500!  That is not bas for a weekend.

BP is jitterish though, monitor it through the day, if it breaks out of the trading range, get out of the position.

[TradingAdmin]

For the more advanced traders, here is an alternative for employing exactly the same strategy.  (If you have the OE, this strategy can be found under your Master strategies, it is called a "SHORT CALL SYNTHETIC STRADDLE").

Note that a Covered Call is exactly the same thing as a Naked Put.  And a Covered Put is exactly the same thing as a Naked Call.  (For that reason when you hear someone talking about  a company that promoted naked option selling and how wrong that is and they should always cover their positions, using covered calls or covered puts - you immediately know the guy has got absolutely no idea what he is talking about - he is actually saying naked option selling is wrong because you should always sell naked, anyway I am diverting)

Our strategy above called for shorting a Call and Shorting a Put.  Since there is more premium in it for us for the Short Call than for the Short Put, we convert the Short Put into a Covered Call.  A Covered Call is shorting a Call and then buying the Futures.  Thus we now Short a Call, then Short another Call and Long the Futures (our second Short Call / Long Futures is a Synthetic Short Put).  We end up with the same result:



The risk graph and the position graph shows us the same result, yet the positions table show we went Short two Calls and Longed the Futures.

WHY WOULD WE RATHER DO IT THIS WAY?
Because of the flexibility it gives us for entering the position!  We know the end result of what we'd like to setup.  We can monitor the BP intraday on say a 15 minutes chart.  When we see a 1-2-3 low and a break above the #2 point, we long the futures.  We now ride up the futures until it looks like turning around or levelling out.  Then only do we short the two Calls.  Since the price has moved up, the short calls will trade at considerably higher prices and we will receive much more premium when shorting them - which will have  huge impact on our overall profitability in the trade.

Likewise, say the pound is trading down intraday.  We short the two Calls and wait, let the BP drop in price.  As soon as we see prices flattening out, or looks like they are turning around, only then do we Long the Futures.  We achieved exactly the same result - we have captured much more profit into our trade position, giving us a much higher chance of success!

[TradingAdmin]

Since the opening (when I started to watch the BP today), been trying to get in.  But it opened towards the bottom of the trading range, which is not good; I personally prefer it trading close to the middle of the range.  Few minutes ago it dipped quite low, very close to the bottom limit of the trading range, so I decided to try and leg into the trade.  Also decided to be a little bit less greedy and go for a put option a little further away.  The BP trading at 130.9, allowed me to short a 130 strike put for 0.0094 points = $587.50.  Hopefully tomorrow it will trade up and allow me to leg into a call before the weekend.

At the moment my trade (only one leg setup) looks like this:

[TradingAdmin]

Friday caused some anxious moments as the BP continued to test the lower end of the trading range.  I monitored it the entire day but it failed to give me an opportunity to leg into a Call option on the upside.  At the close of day I was faced with the decision to get out, or to carry a Naked Put option through the weekend.

In the end I had to look back at the reasons why I was willing to take this trade:

• Because the BP was trading in a trading range.  If it broke out of the trading range, that would be my signal to get out.  By Friday it had not yet broke out of the trading range, so there was no "exit signal" yet
• Because of the very high premium it gave me and with only a few days left to expiry the time decay would be severe - and that is what we were after in this trade.  To exit on Friday, with two days with the market being closed not taken profit off, is against the plan with this trade

I thus decided to stay in.  Monday then was a bit nervous, for I had to wait for the Monday Close in order to get a new data point.  But alas, Monday the BP corrected up and I was able to get out with a profit of $319 - in 4 days time, that is not bad at all for a trade that did not go exactly according to plan!!



Now I could have taken my chances to wait another 4 days to the close to bank the remainder of the $588 we received for this option.  But I was taught (1) not to be greedy and take the money that is on the table and (2) strange things can happen during the last two/three days before options expiry, get out of the market unless you are so far away from your strike price that nothing can hurt you.  I looked at $320 on the table, in just four days, and decided that is enough, I am happy with that and I'm out of there!