Wednesday, March 08, 2006

Straddle and ELN

Straddle is an option trading strategy that investor buy both call and put at the same strike price and expiration date. If the investor believes the stock price would move significantly, but not sure at which direction, the straddle is a good way to pursue.

ELN (Elan Corp. plc) is Biopharmaceuticals company. On March 7, 2006 and March 8, 2006, the FDA is going to review and make decision on whether allow Tysabri, which is Elan’s drug, to return to the market.

The final decision of FDA is unknown, but one thing is for sure that once the result came out, the price of ELN would be either jump or drop. It is a very good candidate for straddle.

ELN’s current price is 12.70. My analysis shows that if we follow the standard strategy, the cost is relative high, so the margin would be reduced and the risk is higher. For example for strike price 12.50 expiration date at April, 2006, both call and put would cost 4.05.

I calculated several combinations. One of the better combinations is buying:
1. Call at strike price 15, expiration date April, 2006
2. Put at strike price 10, expiration date April, 2006
This combination would cost around 2.05. Its max risk is loosing 10%, but has reasonable potential gain >80%.

The following is my detailed analysis about this approach. It was made on last Thursday and “current price” was set as 13.

When the FDA news came out, you should sell the option that against the trend immediately, and hold another one for better margin.

Good luck to who adopt this strategy!


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