The name "Chicken Straddle" came up in a discussion chat room about all the earning surprises, some of these were negative surprises. A person wanted to know if he should stay in a long stock position that had significant long term capital gains, and he did not want those gains to evaporate if the company's earning reports was short be a few cents, possibly causing him a 25-30% unrealized capital losses. I suggested to him that he use options to protect against such a contingency of negative earnings reports and to lock in his capital gains by using some options. After few hours of discussion, he understood what I meant by the term "chicken straddle". For the purpose of this training web site, I am using the term "chicken straddle" in a generic term to describe using options for protection of profits or to maximize those profits by limiting the negative risks associated with long term stock holdings.
If you are not familiar with option trading, then the first thing your broker will tell you is that options are risky! Of course they are risky, risky for his paycheck, because your broker gets paid to sell you stock, not options. Like anything in life, something is risky, only if you don't know all the risks vs. the benefits of using something. For example, "fire" is risky, but if you understand the risks and the rewards of using "fire", the benefits far outweigh the risks. In today's market, especially for long term investors, not using options is a greater risk, than just "buying, holding, and hoping" for good returns. The risk of not using options, is like being a "caveman" who cannot use fire, for protection, for cooked food, and for warmth. You see the average stock investor, is in a life boat, without a paddle on a stock market's ocean. He just drifts along with the tide and the ocean currents, hoping that his life raft will not run aground and no storms are coming to sink his raft. The ol'e saying, what goes up, must come down, happens every day in the ocean of stocks. The tide comes in and goes out, some life rafts, get grounded, some get sunk hitting the rocky shores of reality. Today most stocks are riding on the ocean of hope and optimism, that some day they will reach the promise seas of an eternal bull market. Unfortunately, reality replaces hope and optimism as new innovative products replace older products. The market dynamics through the process of "creative destruction" replaces older products and cut profit margins. A prime example of this creative destruction is buggy whip makers, being replaced by the automobiles. How about long distance telephone companies, being replaced by the internet voip (voice over i. p.)
Getting back to risk, do you think it is risky to have a home, a car, without buying insurance? Is it important to have health insurance or life insurance if you have a young family? Then why would you not buy insurance on your long term stock holdings? I know, your mind is probably glossing over when I mention the word "insurance", especially if you have had to file a claim recently. Have you ever wondered how in the world does an insurance company, take people's money, then when they file a claim, the company writes them a check? Sometimes it not as much as you expect, but at least it not a complete loss, right? You see, insurance companies are masters at risk assessment by using a vast data base of all known risks associated with the type of policy you are buying. Insurance companies were the first "Goggle" to know everything about the risks associated with modern day living.
So, getting back to risks of stock ownership, how about the risk associated with sports betting? Do you think the book makers understand risks? The rules of the gambling industry are "fixed", with the odds in favor of the "house", given enough time at the table, everyone will loose money. Some long term stock holders are playing at Wall Street's gambling table. The longer you stay, the greater your chances of loosing money. When bear market begin, everyone is in shock that circumstances have changed so quickly. The next stage is dis-belief at the losses their portfolios are suffering. The last stage is hope, believing their stocks will regain lost ground. If you have been using my book, The Harmonic Stock Clock book, you could have avoided the most serious of these losses over the last 5 years. During the last 2 years, March 2003 to March 2004, you total gains on the Dow Index was 36%. However, from March 2004 to November 2005, you gains are only 2-3% on the Dow Jones Index. The Standards & Poor's 500 Index faired better, up 40% and 8% respectively. The Russell 2000, was the best performer, up 65% and 14% respectively. The interesting thing about the Russell 2000, is that over 50% of the index is held by institutional investors, and over 1/3 of those stocks have sell signals and warning signs for institutional investors. The institutional investor will hold most stocks until they are trading below the 200 day moving averages, so 1/3 of the Russell 2000 has the potential to sell off very quickly with the coming of the next bear market.
I am offering you some prime picks for the coming storm, which you can monitor and watch how "options work, and to see some "chicken straddle" option plays. I will be providing you the stocks and options strategies based on my screening criteria of the Harmonic Stock Clock book. Your first step in understanding options is to down load the option toolbox free, at the cboe, follow this link:
http://www.cboe.com/LearnCenter/Software.aspx
For those who are familiar with options, you can subscribe to continue your education by having access to the stocks and options portfolio. I have posted previous "chicken straddle" options picks when I have made them available to the public. I will also post stock which meet the harmonic stock clock 'buy' and those who meet the harmonic stock clock "sell" signals for your training and educational purposes. While no stock trading system is perfect, the simplicity of using this program will help you with your own personal portfolio by protecting your profits and limiting your losses. This trading system is base strictly on technical indicators and proprietary signals designed by Doctrader. All information is to be used for educational and training purposes only.
The Chicken Straddle Stocks
These stocks have shown big momentum to the upside, based on future projected earnings. These stock are subjected to sharp sell off to the support signal line. The support signal is the last signal line the price has crossed since being identified by the harmonic stock screen. The way to profit from these momentum stocks are two fold. The best way to profit from these moves is to use options.
The simplest approach is to buy call options that are "in the money". The ideal call option would allow the owner of the call option to earn a 1 dollar profit with the same move on the stock. Since the move upward on these stocks, the option's premium (costs) will be higher. The ratio of stock movement vs. option price movement is called Delta. Delta is measured for 1 to 100 percent. A option with a delta of 100, would give you a 1 to 1 dollar ratio with the stock's price. For example, if you bought a long call option for $2.00 on a stock xyz, if the price of the stock move upward $1.25, your option value would move upward $1.25 just like owning the stock. The downside of this of course, if the stock's price falls by $1.25, the value of the option would fall by the same $1.25 in value. The downside Vs. the upside potential of owning options is why people call owning options risky. A $1.25 move on a stock that is worth $10 is not a big percentage, however a move of $1.25 on a $2.00 option is a huge loss. This risk of falling option prices can be minimized by following some simple rules, which i can teach you.
The other risk factor in owning options is "time". Options expire the 3rd Friday of every month, and depending on the call option you are buying, you will have "time" against you, since the clock is ticking toward expiration day. Time is call "Theta" in options, and it is a decaying factor on all options. There are two strategies to use with these stocks. The first is to use only options, which give you a defined risks, you cannot loose more money that what you pay for the options. So in the example above, if the stock was priced at $27 like Vodafone, the most you could loose would be $2.00 on the call option you own. Unlike the stock holder, who may have bought Vodafone, and watched the stock plunge down to $22.00 a share overnight, loosing $5.00 per share. I know what your are thinking, "I have stops on all my stocks, so it couldn't fall like that!" Wrong, your stops are ineffective because they are triggered only after the first trade in the morning. So if your stop was placed at $25 a share, however, the first trade in the morning starts off at $22 a share, your stops become market orders an are filled immediately. The Chicken Straddle Strategy was designed to prevent your losses and to profit by such unforeseen moves as these.
There are options which allow you to profit from falling prices. These are called "put" options. Continuing with the example above with Vodafone, if you would have bought long a put option at a strike price of $25 dollars, you would have made a profit on the opening gap in the morning.
Now I have to introduce you to the term "strike price". The strike price is where the the option is exercised. Strike prices are set at $5.00 increments for all stocks above $25.00 and at each level below $25.00 at $2.50 for stocks trading below $25.00. I hope you would download the free option toolbox read the tutorial for more detailed explanations.
The purpose of why you are here is to make money, right? I can answer most questions you will have about options, since I have been trading them since 1997.
There are more strategies for options than there are flavors at Baskin Robbins, so the purpose is to keep it simple and to make money.
I modified the simple chicken straddle strategy, for ease and simplicity, because there are more things in life than figuring out all the different strategies of trading options. I use options as a cheap stock substitute for stocks and for insurance against earnings warning and shortfalls.
Using these options as a cheap temporary stock substitute for, short term, I can defined my risks and maximize my rewards.
First, let me describe the most people own a stock. They buy a stock hoping that in the some time in future, they can sell the stock for a profit. Some stock owners buy for short term and some buy for long term. First mistake that most people make is falling in love with a stock. After doing reasearch, they fall in love with the company, even after disappointing earnings they continue to hold onto this stock hoping it will recover lost ground. They feel they have discovered something about the company and soon others will begin to buy, buy, buy the stock. When I began trading, I fell into this mentality of doing "research, homework, or some other type of investigation" to "discover the "hidden value" within the stock's price. Do you think that that those with more money than you haven't hired the best researchers, the best analysis, and the best company spies to tell them inside information? I submit to you that the only way to beat these big money managers is to follow their game plan. Their game plan is reflected within the price of the stock. If the price of the stock is moving higher, then there are more buyers than seller by volume of shares. You see, volume is the fuel to move stocks higher or lower. If there is more selling volumel than the buying volume, then prices will trade lower. If there are more buy orders by volume than sell volume, then prices will move higher. These big money managers have longer time frames of investing than you have, unlike day traders. To give you an example, look at a 5 year stock history of XYZ stock. The price is up from the lows in October of 2002 over 400%. You can see systematic buying with volume spikes higher than average. In the case of XYZ stock, big volume money managers took a position in the stock and was followed by the small investors during the next several months. When prices began to stall, big money once again supplies the buying support to move the stock to the next plateau. Currently the stock is up over 400% from the lows in 2002. When they began to liquidate shares, prices will fall lower with more stock for sell than those for buying.
The Harmonic Stock Clock uses special indicators to identify short term trading and long term trading trends. No stock can ever continue higher with some profit taking. The systematic profit taking can be identified by the Harmonic Stock Clock indicator signals. The Chicken Straddle Strategy was destined to make the best of both worlds. They are designed for sharp sell off with disappointing earnings announcement or for better than expectations earnings. Unlike a stock, you only make money by "buying low and selling high". The old saying "the bigger they are, the harder they fall" come to mind when looking at some of the past high momentum stocks. Just look at some of the stock prices over the last 10 years, you can see those which were higher in 2000 are now still below 50% from their highs. Combine my Harmonic Stock Clock system with the use of options and you will have the best of both worlds. You will have leverage to the upside, and leverage protection to the down side of prices. You cannot do this with stocks, you must be able to use options along with investing in stocks.
Disclaimer: Futures, Forex, stock, and options trading is not appropriate for everyone. There is a substantial risk of loss associated with trading these markets. Losses can and will occur. No system or methodology has ever been developed that can guarantee profits or ensure freedom from losses. No representation or implication is being made that using Doctrader's Harmonic Stock Clock program can generate profits or ensure freedom from losses.