A Straddle on Spirit Airlines?
The essence of a straddle options strategy is for the bold and curious. Why might you consider this tightrope strategy before the Spirit Airlines merger outcome? Buckle up.
Think of a straddle like buying a ticket to both the bull and bear party, hoping one takes off while the other holds the fort. A straddle shines when you expect volatility, a significant price movement in the underlying asset, but are unsure of the direction. A straddle involves simultaneously buying both a call option and a put option for the same underlying stock with the same strike price and expiration date.
As covered previously in this blog, the Spirit Airlines, JetBlue, and DOJ trial verdict is looming, and the market is unusually jittery about the decision. In these situations, a straddle offers us a chance to profit regardless of whether Spirit Airlines/JetBlue win the case and Spirit Airlines zooms to the moon or plummets to the Earth's core.
How Does it Work?
Think of buying a straddle as paying an insurance premium for volatility. You shell out the combined cost of the call and put option (the "straddle cost"), but in return, you get:
Profit potential on both sides: If the price jumps above the strike price, your call option makes money. If it dives below, your put option kicks in. Think of it as having two winning lottery tickets, each for a different outcome.
Limited downside: Your maximum loss is capped at the straddle cost. Even if the underlying asset barely budges, the worst you'll do is lose the premium you paid.
Payoff diagram:
As always, here is the risk to reward to this slightly nerve-wracking but potentially lucrative trade:
Spirit Airlines January 19 2024 Calls $16 Strike are trading for $3.15.
Spirit Airlines January 19 2024 Puts $16 Strike are selling for $3.36.
The total cost for the straddle is $6.51.
The breakeven point will require Spirit Airlines stock to rally to $22.51. (Strike plus premium). Or the Spirit Airlines stock to fall to $9.50. (Strike minus premium). The merger agreement price is $27, so in the event JetBlue and Spirit win the trial, we profit.
A +41% move in the stock on the announcement of the trial outcome is possible, given the current spread in the offer price is currently 70%.
Risk
The Catch (because there's always a catch):
Time is the enemy: Options have expiration dates. If the big price move from the trial announcement doesn't happen before the options expire on Jan 19, 24, your call and put options become worthless, and you lose the straddle cost. However, there is a limited downside. Your maximum loss is capped at the straddle cost of $6.51.
With careful planning and a healthy dose of caution, straddles can be an exciting way to add some extra adrenaline (and maybe some extra returns) to your investment portfolio. Just remember, like that tightrope walker, balance is key!
Ready to learn more? This is just the tip of the iceberg!
Disclaimer:
The information and opinions expressed on this blog are for informational and educational purposes only and should not be construed as financial advice, investment recommendations, or solicitations to buy or sell any securities.
I've seen your discussion on Stockwits on the topic ( Straddle / Collar ). Just getting started with Options, so I'm a little late to the party.
My current position is 1500 Shares and would like to get your opinion on how to protect my investment. Not sure if a stop loss will cut it if the stock tanks.