- Extra premium has been pumped into the price of the option being sold.
- The underlying stock price needs little or no movement to achieve maximum profit.
- 1 and 2 can be realized using front-month options.
Look for an event that produces a major move in the price of stock price accompanied by exceptionally high volume. This can be a move up or down in price.
Most importantly, the cause for this major move must be a event that is essentially concluded after the news is out. We want to see a dramatic move in the stock price followed by a relatively short period of time in which the stock price stabilizes or slightly reverses the big move.
This kind of situation pumps lots of extra value into the front-month options as traders scramble to cover existing positions or attempt to ride the momentum wave in the hope that a second burst will follow.
The aim is to place the short leg of the spread near the extreme price attained during the dramatic move. This may require careful observation for a few days in case there is another surge that needs to exhaust itself.