The “Political Straddle”

Add DIA Calls & Puts

By Bryan Bottarelli
Thursday, September 25, 2008 10:23 AM EDT
Thu, 25 Sep 2008 14:23:00 GMT

PLAY: Buy the DIA October 110 Call (DIA JF) at market, good for the day. Also buy the DIA October 110 Put (DIA VF) at market, good for the day.

Dear Bottarelli Research Member,

Good morning. Under normal circumstances, politics have very little place in our trading alerts. But looking at the market right now, we have a major situation in which “political headline risk” will dictate the next substantial market move.

For example, you very well know that Congress, President Bush, Hank Paulson, Ben Bernanke, and every other influential policymaker is working hard to hammer out the details of the proposed $700 billion revitalization plan. And the clock is ticking. If a bill is not passed through by Friday, I suspect the major market averages could be in store for a substantial fall. But on the other hand, if a bill is indeed passed through, the major market averages could be in for a substantial rally. And when I say “substantial,” I’m talking at least 400 points on top of what we’re seeing already today.

Now, the thing is, there is really no way to predict which direction we’ll move. After all, we’re talking about a pure coin-flip scenario. What we do know, however, is that the recent volatility will spark a large move no matter which situation arises. And in situations like this, it makes perfect sense to establish a position that I’m calling the “political straddle.”

By definition, a “straddle” is an options strategy which has you establish a position in both a call and put with the same strike price and expiration date. Armed with both sides of the strike price, you’ll make money if your asset moves significantly in either direction. And as I outlined above, I believe this is exactly the situation that we have today. In terms of full disclosure, I typically don’t like playing straddle positions, simply because you’re paying premiums on both sides of a strike price to make a smaller return (after all, any gains you achieve on one side are taken away from losses on the other side). But in a politically-charged situation like we have now, one which carries such tremendous global financial impact, I think we’ll witness a move large enough to achieve a nice return. Therefore, I’d like to go ahead and establish this political straddle position now, and we’ll play is via the Dow Diamonds Trust (DIA – AMEX).

DIA

*Tactical Note: I’d prefer to play a straddle on an ultra-short play like the DXD, SDS, or DUG, but as I review the options strings of all these assets this morning, the pricing still appears totally messed up. Typically, the strike prices on the options re-calibrate the following morning after a special dividend or capital gain disbursement (which is what we had in these ultra-short plays yesterday). But as I write, all of the options strings on these ultra-short plays remains un-corrected, so instead we’ll play the DIA. On that note, here’s the play:

PLAY: Buy the DIA October 110 Call (DIA JF) at market, good for the day. Also buy the DIA October 110 Put (DIA VF) at market, good for the day. Buy each position on a 1 to 1 ratio, meaning that you should construct your straddle by buying one call for every one put. The total cost of the straddle position should be just around $7.10. Therefore, selling off the basket of calls and puts for over $7.10 will be our profit goal. Do not place a protective stop limit order or sniper sell order on any position right now, as both the call and the put are designed to work together. I’ll manage this position via our daily trading alerts.

At the same time, maintain your GLD October 87 Calls (GLD JI), DBA November 33 Calls (DBA KG), KMB October 65 Calls (KMB JM), and TSO October 20 Calls (TSO JD).TSO looks like it’s on the verge of breaking into the profit zone, so hopefully we’ll be taking profits later in the session! Until then…

Lock and load!

Sincerely,

Bryan Bottarelli

Bryan Bottarelli
Editor, Bottarelli Research

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