Eli Lilly stock is down 20% in the last month and implied volatility has risen from 27% to 37%.
Lilly stock has an IV percentile of 86%, which means the current level of IV is higher than 86% of all other occurrences in the last 12 months.
As option traders, we can take advantage of that high volatility 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.
'Naked' Trade On Eli Lilly Stock Is Risky
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 because 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.
Assuming traders believe that Eli Lilly will trade sideways over the next few weeks. They could look to sell a Dec. 6 put with a strike price of 680 and a 790 call.
The 680 put could be sold for around $5.85 and the 790 call could be sold for around $5.40.
Selling those two options would generate a total of $1,125 in premium. That is the maximum possible gain on the trade if Eli Lilly closes between 680 and 790 on the day of expiration.
To work out the breakeven price of the trade, take the lower strike price of 680 minus the total premium received of $11.25, which gives 668.75. Then on the call side, take the call strike and add the premium, which gives 801.25.
This trade is a short vega trade. That means 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 breakeven points.
According to the IBD Stock Checkup, Eli Lilly stock is ranked No. 2 in its industry group. It has a Composite Rating of 59, an EPS Rating of 94 and a Relative Strength Rating of 24.
Eli Lilly is a global pharmaceutical firm headquartered in Indianapolis. The company's diverse portfolio includes treatments for diabetes, oncology, immunology, and neuroscience.
Notably, Eli Lilly was among the first to produce human insulin using recombinant DNA technology, marking a significant advancement in diabetes care.
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
