A Strategy for a Volatile Stock: The Long Strangle

FEYE is an abnormally volatile stock. But you don’t need to take my word for it; just check the stock chart below to see the rollercoaster that is FEYE:

The Technical Analysis for FEYE

The first thing you should notice is a strong downward trend. FEYE has been trending downward since the beginning of March. Both the 10-day and the 30-day moving averages are dropping fast, and the space between them (in the chart) is more-or-less constant, implying that this trend will continue.

But to contradict this trend, the RSI is at an incredibly low 20.06, implying that the stock is oversold. Thus, standard technical analysis would predict that this downward trend reverse, shooting back upward.

Yet when you look at the ADX, you see a high value: nearly 45, implying a strong momentum. This information really doesn’t add much to what we know, but it does confirm what we see in the moving averages: a downward trend that does not seem to be stopping.

In addition, for the candlestick analysis, you can see a bearish engulfing candle on May 6. This candle stick implies a continuation of the bearish trend, at least for the short term. Obviously, this held true for the three days following May 6. However, bearish engulfing candles are short-lived and can imply a bullish reversal after a short-term downward trend. Thus, this candlestick is rather ambiguous in this chart and should probably be disregarded.

Now here’s where things get interesting: May 7 displayed a large downward gap. On this day, the stock price opened nearly 10 dollars lower than it closed on the previous day. Downward gaps tend to imply the stock will continue downward for a period of time. But in the long run, a downward gap is filled, with the stock reversing its downward trend.

What should we make of all this?

My Prediction for FEYE

The extreme volatility of FEYE doesn’t make it appropriate for selling calls or puts. Yet the mixed messages for the trend direction make it unsuitable for a call or put. I would give FEYE a 49/49 chance of it moving in either direction. Of course, that leaves 2% for stability (which seems unlikely).

This is the perfect type of stock for a long strangle: a strategy in which you get the advantages of both a call and a put, albeit at a higher price.

My Move | FEYE Long Strangle

FEYE is currently at 26.44. I will buy five call contracts at the strike price of 26.50 (slightly out of the money) and five put contracts at 26.00 (also slightly out of the money). No matter the direction FEYE takes, I should stand to profit provided it moves far enough. Thus, this bet is about movement, not direction.

Cost to buy 5 calls at 26.50: ($625)

Cost to buy 5 puts at 26.00: ($550)

Net cost of long strangle: ($1175)