Known in technical analysis as the broadening formation, the “megaphone pattern” — as traders colloquially refer to it — represents a favorite dynamic to trade. That’s because megaphones don’t offer the most confidence for directional plays but can generally be relied upon to provide wild volatility. And that plays into the hands of the long iron condor.
Specifically, uranium specialist Cameco (CCJ) just printed what appears to be a classic broadening formation. According to the godfather of technical analysis, John J. Murphy, such patterns exhibit successive higher peaks and declining troughs. A violation of the final trough completes the bearish implication. Murphy notes that these formations are difficult to trade and fortunately are relatively rare.
From a directional standpoint, I wholeheartedly agree. Sometimes, what appears to be a broadening top becomes instead a fake-out, leading to dramatic gains. Other times, the pattern facilitates what should be the expected outcome. It really can be a nightmare. Fortunately, the long iron condor is a play on rising volatility instead of a particular direction.
Essentially, this type of condor is a combination of a bear put spread and a bull call spread. To use laymen’s terms, these two vertical spreads represent profitability endzones. The idea is to get the ball across either line, symbolized by the outer strike prices of the condor. So, the security must either shoot higher or collapse. If the magnitude of movement is enough, you get the prize.
By logical deduction, the worst thing that can happen with a long iron condor trade is if the target security hardly moves at all. That’s a no-no. However, the megaphone pattern makes this outcome unlikely.
A Lull in Volatility May Correct Higher
It’s not just about a visual interpretation of the megaphone pattern that makes me suspicious of incoming volatility for CCJ stock. Rather, it’s the ebb and flow of implied volatility (IV) or the market’s expectation of asset kinesis.
At the moment, IV sits at 42.21%, which is not that far off from the historical volatility of 41.59%. That said, by looking at Cameco’s options history — a feature that’s available to Barchart Premier users — the security’s IV rank or relative volatility sits quite low at 17.32%. Previously in November, this metric breached the 53% mark.
Interestingly, earlier in the year when the megaphone pattern started developing in earnest, the IV rank soared to almost 90%. Another return of chaotic trading patterns in CCJ stock could be very fruitful for a long iron condor. Again, the benefit of this condor trade is that it’s a wager on kinesis, not on direction.
This options strategy could also be useful for those who are skittish about being short (even if only temporarily) on companies they believe in. To be clear, I’m a long-term bull on nuclear energy, especially if we enter a cryptocurrency-friendly environment. All the signs seem to point to a crypto renaissance. However, these digital assets must come from somewhere and that takes power — lots of power.
One Long Iron Condor Stands Above the Rest
If I may be blunt, finding viable iron condors can be a true pain. Since you’re paying two premiums — one for the bear put spread and the other for the bull call spread — it’s in your best interest to find a somewhat balanced condor. Otherwise, you might as well just buy a bullish or bearish vertical spread.
Among the more than 70 long iron condors for the options chain expiring Dec. 20, the 52.00P | 53.00P || 57.00C | 58.00C stands above the rest. This trade requires a net debit of $75 to be paid upfront, which is also the most you can lose in this bet. If the transaction is fully successful — meaning that CCJ stock falls to $52 or rises to $58 — the speculator collects $25 or a 33.33% payout.
At first glance, that doesn’t sound like a whole lot and admittedly, it’s a risky play. However, most of the other condors will likely never be profitable. With the 52.00P | 53.00P || 57.00C | 58.00C, the upper and lower breakeven prices are $57.75 and $52.25, respectively.
With this setup, there’s a 59% chance that the trade will be at least somewhat profitable (based on the integration of the breakeven points with CCJ’s weekly probability matrix). It’s true that the slightly narrower 53.00P | 54.00P || 57.00C | 58.00C offers a higher success ratio. But at only 60.5%, the projected win rate isn’t that big compared to the reward penalty (a payout of merely 20.48%).
So, if you want to play the volatility game, take a long look at the 52.00P | 53.00P || 57.00C | 58.00C. It just might get the job done while mitigating your opportunity cost.
