fair value of straddle?

Discussion in 'Options' started by mizhael, Jan 13, 2009.

  1. I saw in the news today people are buying (or selling) JPM straddles.

    I wanted to long some straddle too.

    However, is there a way to figure out whether the quoted price is already too high or not?

    If the quoted price is already too high, maybe I should short the straddle?

    The InteractiveBrokers TWS Option Trader and Spread Trader don't provide much insight here to help me make decisions, any more thoughts about how to make decisions about buying or selling straddles?

    Thanks a lot!
  2. The option prices are determined by several factors, and the most influential is the implied volatility (IV). IV is an estimate of the FUTURE volatility of the underlying stock.

    Thus, in truth, it's impossible to know whether the options are priced high, low, or just right. Only when we see the future (between now and the option's expiration) volatility of the stock, will we know.

    But that will be too late to trade the straddle. You must try to determine if the IV (and thus the straddle) is too high. One way to do that is to compare the past volatility of the stock with the current IV. Historical volatility is available at the optionstrategist.com.

    But that's not good enough either because stocks tend to be more volatile when news is announced.

    There's more to it, but that's the general idea and you are going to be forced to make your best guess. You can determine how much the stock moved the last few times earnings were released and perhaps you can make a good guess of future volatility based on that data.

  3. You buy a straddle because you think that the underlying is going to move a lot in one diirection. You just don't know which one.

    You sell a straddle because you think that the underlying isn't going to move a lot in either diirection and will stay within the profit range provided by the premiums received.

    You don't buy (or sell) a straddle just because it's perceived to be over or under valued. It's a factor in the decision of which strategy to utilize but it isn't THE only factor.