Adobe is showing an IV percentile of 46%, which means the current level of implied volatility is higher than 46% of all other occurrences in the last 12 months.
When implied volatility is high, it can be a good time to be an option seller rather than a buyer.
Part of the reason for the high volatility in Adobe stock is because the company will report earnings Thursday after the market close.
Option traders can take advantage of the high volatility by selling a strangle. This option trading strategy involves selling an out-of-the-money put and an out-of-the-money call with the same expiration date.
This trade generates a premium for the option seller, but it does come with risks. A short strangle is an unprotected trade, sometimes referred to as a "naked" trade. Naked options can be risky because they expose the trader to potentially unlimited losses if the stock makes a big move.
Big Gains If Adobe Trades Sideways
However, if the trader is right and the stock trades sideways, solid gains are also possible.
Assuming a trader believes that Adobe stock will trade sideways over earnings, they could look to sell a Sept. 15, 525-strike put and a Sept. 15, 600-strike call.
The 525 put can be sold for around $2.50 per share and the 600 call could be sold for around $3.85.
Selling those two options would generate a total of $635 in premium ($2.50 + $3.85 x 100.) That is the maximum possible gain on the trade if Adobe stock closes between 525 and 600 on the day of expiration.
To work out the break-even price of the trade, subtract the total premium received from the put strike price and add the premium to the call strike price.
That gives us break-even prices of 518.65 and 606.35.
Watch Out For Rise In Implied Volatility
This trade is a short vega trade. That means if implied volatility increases early in the trade, losses could occur.
With a trade like this the potential losses are unlimited and a lot higher than the potential gains. So traders want to be very confident that the stock is going to remain flat over the course of the trade.
A stop loss could be placed at the break-even points. Adobe stock has stayed within the expected range following four of the last six earnings reports.
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According to IBD Stock Checkup, Adobe stock is ranked No. 1 in its group and has a best-possible Composite Rating of 99, an EPS Rating of 96 and a Relative Strength Rating of 96.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
