Cisco Systems stock is down 8% year to date and is showing very high implied volatility.
As option traders, we can take advantage of that high volatility in Cisco stock by selling a short strangle.
A short strangle involves selling an out-of-the-money put and an out-of-the-money call with the same strike price and the same expiration date.
This trade generates a large amount of 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 as they expose the trader to potentially unlimited losses if the stock makes a big move.
However, if the trader is right and the stock trades sideways, the trader gets to keep the full premium.
Setting Up Cisco Stock Trade
Assuming a trader believes that Cisco stock will trade sideways over the next few weeks, he or she could look to sell an Aug. 16, 44 put and an Aug. 16, 49 call.
The 44 put could be sold for around $0.57 and the 49 call could be sold for around $0.56.
Selling those two options would generate a total of $113 in premium. That is the maximum possible gain on the trade if Cisco stock closes between 44 and 49 on the day of expiration.
To work out the break-even price of the trade, take the lower strike price of 44 minus the total premium received of $1.13 which gives 42.87. Then on the call side, take the call strike and add the premium, which gives 50.13.
This trade is a short vega trade. It means that if implied volatility increases early in the trade, losses could occur.
Potential Losses Unlimited
Short strangles are an advanced option strategy, so if all that sounds confusing, it's best not to trade them.
With a trade like this the potential losses are unlimited and a lot higher than the potential gains. So traders would 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.
According to the IBD Stock Checkup, Cisco Systems stock is ranked No. 7 in its group and has a Composite Rating of 45, an EPS Rating of 60 and a Relative Strength Rating of 18.
Cisco Systems is a network technology company offering products and services to companies, commercial users and individuals. Cisco is rapidly expanding its presence in network security.
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 X/Twitter at @OptiontradinIQ
