Straddles Profit Potential

Discussion in 'Options' started by jgiasi, Apr 29, 2009.

  1. jgiasi

    jgiasi

    Can anyone advise as to how large a move is needed (up or down) for an at the money straddle(simuntaneous buy of both a put and a call) on the SPY to become profitable.

    Thanks, Jennie
     
  2. just21

    just21

    Is this a school project?
     
  3. The answer to your question of course depends on the time and if not at expiration, then the IV.

    Purely at expiration, the move simply needs to be large enough to cover the costs of the put and the call. A quick example should make it easy to understand:

    Stock XYZ is at $50
    50 strike call for a given time costs $300
    50 strike put for a given time costs $250

    Straddle cost = $550

    Stock must then move > 5.5 points away from $50 for the straddle to be in the money at expiration.

    i.e. - stock is at $55.50 - call and straddle will be worth $550
    i.e. - stock is at $56.00 - call and straddle will be worth $600

    i.e. - stock is at $44.50 - put and straddle will be worth $550
    i.e. - stock is at $44.00 - put and straddle will be worth $600

    So, at expiration, the stock needs to move the number of points that the put + call combined to cost plus just a bit more to profit. Obviously a bigger move results in bigger profits.

    Before expiration, a smaller move can make a straddle profitable, or theoretically even no move if IV (Implied Volatility) increases enough.

    It's often not considered wise to hold a straddle all the way to expiration - most straddle holders I think tend to use "time stops" to close a position before time expires on them and if a stock makes a huge move on a given day, then they take profits on that day (not necessarily of course).

    JJacksET4
     
  4. This is a great question, for the trader needs to understand the dynamics of option trading. It is NOT about waiting until expiration. You need to follow your trades daily and make adjustments as needed. Again, forget about expiration. For example, suppose the market has been trading sideways, and you expect a QUICK move (slow moves will kill long options, for theta will eat up your profits from the move) either up or down, but you are not sure. Place the long straddle. Now suppose the ATM put's premium is 4 and the ATM call's premium is 3.8. The SPY tanks big time (let's say 8 points) in three days. Your long put may be worth 9 while your call is worth 1.00. Well at this point, let's see where we are. You paid 7.80 to enter the trade (less commissions). If you exited both legs at this point, you have a 2.2 profit (28% profit). Not bad for three days. Now suppose, you exit the winning side only. Now, if the market rebounds, you make money on the call side. Again, forget about expiration. when profit goals are reached, get out and place new trades. I always exit longs--no matter what--the Friday before expiration, so that I get some premium back. Now, in reality, if the call is OTM quite a bit, it is cabineted and you may not have any buyers. So, I may leave the long call alone until expiration or until a buyer shows up. On the other hand, long puts always seem to have some premium left.
     
  5. More often than not you won’t do very well trying to leg out of long straddles via market timing. Straddles are really gamma and vega plays. IF you’re looking to scalp gamma then the ATM straddles is chock full of and you’re much better off trading the stock vs. the straddle then trading the legs of the straddle. If your reason for buying the straddle was purely based on your perception that volatility is going up you’re still not going to want to leg out of the straddle.

    Even better is to trade options vs. options and if you were long the straddle rather than closing out the legs if you get a delta move or a vol pop you could sell other options vs the straddle, locking in the vega/delta scalps.
     
  6. Is it really better to gamma scalp with options as opposed to using the underlying stock for gamma scalping. The commission cost and the bid/ask spread would favor using the stock instead of an option to lock-in profits as a delta neutral play...

    Walt
     
  7. Would you be so kind and grade the various replies?

    :)
     
  8. pengw

    pengw

    With long straddle, you are racing against time, also you are betting IV going up, at least won't drop because it is a long vega and short theta play.

    See attached chart, for Oct spy long straddle in the chart, with each day passing, you are losing $11.46, you need spy to go up 1.6% or down -1% just to stay even with one day passing. Also you are risking IV collapse. The bid/ask spread for spy is relately small, that is good news, but you have to monitor the position closely, be ready to close out the position once your pre-trade assumption proved to be wrong.

    Try the Quick Loss function in the Options Lab ( http://www.TheOptionsLab.com ), then you will see the enemy of a long straddle position is time, IV drop AND whipsaw price action.
     
  9. Retief

    Retief

    Below is an analysis of a SPY straddle for October 09 expiration, long 4 puts @ a strike of 104 and long 200 shares of the underlying. For break even at expiration, the underlying either needs to have either declined by 4.84% or increased by 3.98%.

    [​IMG]

    [​IMG]
     
  10. I think the stock is better because the B/A spread is a killer on the options. Also, you can fine tune the position's delta with odd lots of stock.
     
    #10     Sep 25, 2009