Hello, I heard that straddles are used when you are anticipating a large price movement, but are unsure of the direction. You are supposed buy at-the-money puts and calls. But if the stock goes up, the put loses value. And if the stock drops, the call loses value. So how do you make money? I can only think this: If the share price rises, the call value appreciates more than the put value depreciates. And if the share price drops, the put value appreciates more than the call value depreciates. Is that how it works?
Yeah, that's basically how it works. Effectively what you are doing is a volatility play. Calls and puts are priced (in part) based on the market's anticipation of the move in the underlying, so if you are doing this trade, that means you are anticipating that the actual move will be larger than the market is currently pricing. If you think the move will be less, then you can do the opposite trade (sell both the put and call), but this has more potential max loss.
If the directional move is larger than the net debit of the straddle. I buy the straddle for $5.00 going out 2 months, I need the stock to go up or down more than $5.00. Enough to make up for the times I do this and lose money. You need to have a material expectation that the market is underpricing the options. Just expecting a move of 6 points might not be enough, as if you do this with 10 symbols, you will have losers.
Not an options expert myself, but wouldn't suggest trying to make a career of this play....nor any play which extracts a high premium from you.
Thanks, Robert. That makes perfect sense. You have to have the price jump outpace the net cost of buying both the options. Also, you made a great point about the implied volatility- a stock that is likely to move a lot will have a more expensive option. So you have to outpace that as well.
Look into Strangles instead. Each leg is 1-strike or more OTM. They are cheaper. And in most cases more profitable than the Straddle.
When going long, you hope volatility goes up and you take advantage of delta and gamma when there is a large stock price move.
stock xyz = $100 straddle price $5 Stock goes up to 200. Call = $100, Put = $0. You made 100-5 = $95. Very simple There is more to this tho. You should start to learn about the greeks if you want to get into options trading.
??? They are a pure volatility play. The proper way to trade a strangle/strangle. Is to make a prediction on volatility and delta hedge until the profit/loss is realized. Also strangles are not more profitable than strangles. They both have there merits.