Buying Straddles & Selling Premium

Discussion in 'Options' started by traderjimbo, May 14, 2003.

  2. Trajan


  3. very helpful
  4. What is/are...

    1. The underlying
    2. The months
    3. Your amount of capital you are willing to risk

  5. TraderJimbo:
    Check Larry McMillan's website ( for a decent conservative program that shows you how to choose and manage straddle purchases. If for some reason, you want to use straddles to sell premium, chapter 20 in McMillan's book "Options as a Strategic Investment" provides an overview of whats involved. Another good instructional work relating to selling premium via straddles is Gallacher's book "The Options Edge". My own advice for what its worth is avoid selling straddles unless you are very good at risk management. Why? Because when you sell straddles, your exposure to risk is not linear, meaning you can wake up one morning and find your account is (suddenly) under water big time! Be careful. Regards, Steve46
  6. Trajan


    Hey, I answered one of three definitively. My pithy Metooxx like answer wasn't as imformative as his.

    This trade is actually my favorite position to put on. Played right, it gives you many opportunities to profit in a variety of different scenarios. How it works depends on conditions, some of which Hardrock mentions. My preference is to buy one of the front two months atm straddle and then sell the fuck out of the front month otm calls. I would do this on a 1 to 1 or up to 3 to 1(wimped out on this over csco earnings but currently am 3 to 1, I'm happy that the 15% move on Friday and Monday didn't start from where csco ended on earnings becuase that would have been painful). Like Hardrock said, it depends on the stock.

    The position is refered to as a front spread, in other words, the ideal situation would be for the stock to slowly move up to the short strike at expiration. As that is unlikely, the next best scenario would be a move up to that point at most speeds except gaps. The reason is that IV typically comes in as a stock moves higher. Btw, this was the wrong position to have on during the late 90's when internet stocks blew through mulitiple strikes in one day. To adjust this position on the move up, you would most likely hit put bids as it moves up and sell stock delta neutral(for the whole position). When it gets to the short strike and goes through, you buy back in that line, sell stock and the next line up. In other words, you roll up your short premium by buying call spreads or even sell out the previous long strike, in this scenario we'll roll up. Now your ready for a continued move up and further decay or a decline. As most traders know, stocks go down a lot harder than they go up. This aspect is a huge factor in this play. It's akin to why so many people say the market will decline as the VIX approaches a certain level.

    If the stock moves down, you have the short calls getting annihilated and an opportunity to hit the book on the long calls as it moves lower. Also, as mentioned above, the stock will go down faster thus neutralizing to an extent the premium decay as a stock approaches the long premium strike. However, depending on how fast and far the stock moves, you may not have much time to dump long premium. It's a tough call. Also, it may not be beneficial to buy long premium as it approaches a new strike and rolling down. Factors such as the IV edge given up or total debit/credit play into this scenario. IV's will often pop to the downside, especially on sharp moves. It could be better to sell the strike or the next one down. In fact, this is the best way to adjust the position when you have a vol pop. You are generating short deltas and need to get neutral, plus you are taking profit on the long vega you now have.

    Let me emphasize something at this point, the ideal way to hedge a long gamma/vega postion is to sell premium. The ideal way to hedge short premium is to buy in options. This is true whether it is to take a profit or cutting a loss. Hence above, when the stock gets to you strike, you buy in premium, the best bet is the line your short. On the downside, you sell a big fat juicy put. Unfortunately, sometimes they don't come in for the puts, it sucks so just hit a bid or trade stock.

    If the stock stays the same, you have gamma or theta decay, depending on the position, to trade deltas. In other words, whether long or short premium, you always have something covering your ass. It's either decay to your benifit or gamma helping you out, however this depends on an ability to trade. I find short premium to be more forgiving; long premium to be more profitable. So, if you know vol will come in as the stock moves up, and are aware that itm calls will have a larger delta when IV's come in and otm calls a lower delta at a lower IV, you have room to fuck around. The position may have a long 1000 theta decay and short 500 gamma, you should be a savvy enough trader to know whether to hedge by buying 500 shares after a half point up or selling 500 3/4 of point up. If your wrong, you won't be too fucked as long as it is recognized and properly traded. A different way to look at it is to take out otm calls from the position, hence short deltas at the same time. You can do this because of the lean delta factor, have deltas toward long premium and opposite towards short.

    This explanation is incomplete but jives with what I tried to do in my journal which you should look over. My trade in it was a variation on this with the exception of not selling otm calls from the outset. I stopped the journal for a little while because I was bored and haven't done anything since besides( except sell 15 15 calls, sell 20 July 17c and but 17 July 17c).