Should you only open the position when the underlying is trading ATM or near it? Is it a big no-no when the stock is 2 pts or so away from the strike? Thanks!
Makes no difference. One position risks less money but has lower chance of being profitable, the other position costs more and has a higher chance of being profitable. Choice is up to you. Straddles rarely make money, they are very high risk. Did todays action on RIMM and AAPL get you interested?
With the long straddle, you have a high probability of losing money, but the risk is limited to the purchase price, so I wouldn't call it "very high risk". That said, 95% of the time I'd sell straddles over buying them.
If the stock is at 47 and you buy the 45 straddle you are in essence bullish. If you buy the 50 straddle you are bearish. Your other option is to buy a strangle which would be to buy the 45 put and the 50 call. The reason most straddle "lose money" is because the breakeven point can be 10% away from the current price. People like to buy straddles / strangles before earnings because they think it is a win win trade, but the volatility crunch kills you if there is no move. The real purpose of buying a straddle or strangle is if you are betting on an increase in volatility. You have to make sure you are buying it when volatility is really low. Hope that answers your question!
But you are naked once the stock moves out of the "range", say a major announcement overnight and wipe out your account.
If you're terrified of being "wiped out", you'd be a little better off by doing straddles/strangles on indices instead. They're much less likely to gap huge against you. You won't have to be concerned as much with company-specific chart-busting news.
I've got kind of a dumb question .. but how do you buy an option based on an index? Are you referring to trading options on an ETF like SPY that follows the S&P 500?
There are options on most indices like SPX, NDX, DJX, OEX (XEO), RUT and etc. ETFs are an alternative, but you can go directly with index options. Here's a link to the CBOE's index options page.
What is confusing to me is that there are so many choices. Just for the s&p 500 you can trade options on ES, the index, the ETF, and the big futures contract that I know of. Maybe I missed some. Can anyone explain the advantages and disadvantages of trading each? I'm leaning towards ES since it is $50/point and since the tax treatment is like a futures for us U.S. traders. But I'm really not sure if this is the best contract to trade for me. MTE?