Markets for Short Straddles

Discussion in 'Options' started by stevenpaul, Dec 20, 2010.

  1. Hello friends,

    As in all strategies, success in short straddling is likely contingent in part on practical factors such as liquidity, bid-ask spread, margin requirements, etc. There's also the factor of the underlier's style of price action, i.e. whether it makes abrupt moves (e.g. energies and grains) or more subtle, rounded moves (e.g. short term treasury securities, dollar index, eurodollar). Of course, every market is prone to making sharp moves at times and dull moves at other times, but overall, some markets just seem to carry more statistical volatility risk than others. That's not to say that zippy markets are unsuited to short straddles. The extra premium from the higher IV of those markets may offset any statistical volatility. Therein is the difficulty in choosing a market: Is a slow, dull, market with low premium options better for short straddling, or a bronco of a market with expensive, richly protective options?

    In view of both practical concerns and the obvious risk of loss due to short gamma, which futures markets are best suited to short straddling in your opinions? Of course, we should consider implied volatility in making a final choice, but how to do that is a whole other topic. Assuming the status of IV to be equal in all candidate markets, what underlying candidate contracts would you consider?

    Thanks so much for your wisdom and insight!
  2. rosy2


  3. As a rule; don't trade them. For many reasons it's preferable to fly them off. I sell some LEAPS straddles on occasion, but never anything under 6 months. I always carry protection. :p
  4. 1) When trading short-straddles/strangles, you're generally in a race against time before a "large" loss comes along.
    2) If you believe "that", you would tend to want to protect yourself from that eventual expectation.
    3) If you want to go "naked", it's better to go with a "slower" moving market, i.e. a large-cap stock index.
    4) With other markets, it can help if you know that there is some type of scheduled news release that can create implied volatility decline. Ideally, after the report, the market doesn't move too far away from your strike price(s) and you'll collect some premium decay. :cool:
  5. Great feedback, everybody! Thanks.

    Atticus, may I ask what prompts you to sell LEAPS straddles, when you do? Is it the lower gamma, or perhaps the higher vega?

    Looking forward to more food for thought.
  6. sle


    Yeah, the X-mass quiet...

    In terms of selling straddles - you want to find (a) an asset which you expect to realize lower then implied and (b) an asset with high a/c. In fact, AC might be even more important then the actual vol, if you hedge judiciously.
  7. Is it just my perception, or is the viewpoint that short straddles are relatively high risk strategies quite prevalent? It seems like the majority of the contributors here on ET and elsewhere look askance on short straddling, writing off the strategy altogether as being entirely too risky. Yet, I don't hear much about the dangers of trading outright futures contracts or trading stocks on margin. It almost seems like the prevailing viewpoint on short straddles is that they are about the most dangerous of all strategies, even more dangerous than buying a futures contract. Is that just my imagination, or do folks actually think that? If so, why do they? Seems to me short straddles are actually considerably safer than trading an outright futures contract (long or short) or trading stock on margin. In the event of a big move, at least the trader enjoys the hedge of the trade's winning leg. At worst, the short straddler suffers exposure tantamount to a single losing outright contract in the underlying. Dealing with losses doesn't seem to scare off most futures traders, but losses are unthinkable to short straddlers, it seems.

    I trade with a group online sometimes, and they're always dropping $200 on such and such trade that goes bad. Of course, it's all perfectly wonderful because they diligently observed their stops, even if the trade did only last about 5 seconds. Contrastingly, I had a short straddle on the eurusd and 5-year note futures. There was a fair bit of volatility (.40% and .33% respectively) and yet the trade was very stable throughout the trading day and yielded a profit of .75% on the day. Had I been trying to call direction day trading, I know I would have gotten stopped out 3 or 4 times. But with the horrendously risky short straddle, I easily made a tidy little low-stress profit under the same circumstances. Admittedly, I am not in the habit of holding these trades too long. I try to keep them day-trades to avoid headline risk.
  8. You can lose more on a straddle than the underlying. Not necessarily directionally, but to vega. Imagine you're long 100 XYZ from 100 and the stock drops to 98; you're out 2 on shares. Say it's a drug stock and some trial results appear on the calendar. Vol rallies 1000bp and your short 100 straddle loses 4 on its 40 vegas.

    It's difficult to lose more on the straddle due to direction, but it's also possible. I like straddles just fine, but it's more favorable to limit vol-risk, or simply have hard stops via the wings.
  9. sle


    The harsh reality is that you can lose more then the initial premium on a delta-hedged position. Both long and short, actually.
    #10     Dec 23, 2010