Lehman Brothers is pitching to institutional and high-net-worth clients a short-term strangle strategy that aims to take advantage of the current high levels of near-term volatility of certain stocks in the Standard & Poor's 500. Lehman last week drew up a list of stocks, including Apple Computer and Hewlett-Packard, for which this trade makes sense, said Paul Lieberman, v.p., equity derivatives and quantitative research in New York.
The trade entails buying shares in the company and selling an out-of-the-money put option and an out-of-the-money call option. Typical maturities for the recommended options were about one month, and typical strikes, about 20-30% out-of-the-money,
In this trade, the investor wins whether the stock price goes up or down, because the premium earned by selling the strangle effectively discounts the purchase price of the underlying stock, said Lieberman. If the call is in the money, the investor can sell the stock at a significant premium to its current levels. If the put is in the money, the investor can buy the stock at a hefty discount to its current levels.
The stocks that Lehman touted for this strategy last week reside mainly in the technology sector, because, in general, volatility on tech stocks is higher. With vol high, premiums earned on selling the options are high.
Lehman screened for stocks with relatively liquid options and strikes. It chose stocks whose listed call strikes fell within a range between at-the-money and 30% out-of-the-money and whose listed put strikes fell within a range between at-the-money and 30% out-of-the-money. "The idea is to leave breathing room for the stock to move up or down," said Lieberman. The firm also looked for options where a 30% out-of-the money put strike is below the 52-week low of the stock because "if it [the share price] goes lower than that [the 52-week low], you're getting a really cheap stock," said Lieberman. Other stocks for which this trade made sense last week include Sun Microsystems, Walt Disney, and Motorola. Investors who wish to pick specific strikes or terms that aren't available in listed contracts can sell the strangle over-the-counter.
