Delta Neutral Event Trade

I put on two different delta neutral trades this morning.

The Event

Today, the new Treasury Secretary, Tim Geithner, was scheduled to speak at 11 AM about the economy.  As an added bonus, the Chairman of the Federal Reserve, Ben Bernanke is speaking at 1 PM. Yesterday’s trading was flat waiting for his speech.  The market thought it was important enough to wait for

The idea is that a spike up or down in the price will increase the volatility of the options, increasing their value.  Also, if the price moves down, the volatility increases more.  The problem with this trade is that the implied volatility of financial stocks is already high, pricing in these kinds of large moves.

I bought a straddle and a strangle on JP Morgan Chase.  Here is how it works.

The Straddle

JP Morgan Chase closed yesterday at 27.28.  .

So I bought a put and a call both with a strike price of 27.  The call cost me $1.97 and the put cost me $1.76.

Total cost: $3.73

The idea is that the financial stocks will have the biggest reaction to Geithner’s speech.

The Strangle

To compare returns, I also bought a strangle, or combination, which was a 29 call and a 26 put.  The 29 call cost me $1.01 and the 26 put cost $1.31.

Total cost: $2.32

These are both nearly delta neutral trades which means that they shouldn’t change in value as the underlying stock moves.

So why would I do this trade?

Chase has moved down $2 as of 1:30 PM which is a 7% move.  Both puts are in the money and so are trading with a delta closer to 1.  The 27 call is now out of the money and so has a lower delta than the 27 put, so what should happen in that the 27 put should gain value faster than the 27 call loses value.

For the strangle, both options started out of the money about the same distance from the stock price.  Now the put is in the money and has a much higher delta than the call which is now more out of the money.  So again, the put should gain value faster than the call loses value.

We will see how it all ends.