Hey newguy, here is the easy way to solve this. Trade that way for 6 months and get back to us with the results. Results have an amazing way of providing clarity to a situation. Go ahead and arb these markets. Only then will you get the answer you are looking for. Debating it on here is useless. Nevermind the fact that I'm sure I've met hundreds of guys over my trading tenure that have attempted to do just what you are talking about with rows and rows of computers and rows and rows of really smart guys behind them and incredible technological resources at their disposal and yet they tell me it's next to impossible. Maybe you know something they don't. Like I said, the easy way to get an answer is to take action. It's very possible you are right and we are wrong. Don't let us stop you. real trading with real money is the only way to get the real truth.
OR one COULD put in a stop limit buy order, once the sold straddle has become profitable to the point that buying a protective strangle would make it a break-even trade. That way, one is not buying the higher (or not) IV strangle. But that would be cheap route. It does not prevent gap risk, which is what one always has to fear when selling straddles. Personally I'd still buy the strangle and keep the short straddle (iron butterfly), and perhaps put on a new straddle, if the price has moved away from the strike of the original sold straddle.
No one here is an idiot t'man. Knowing "where it will not go" is the same, imo, as knowing where it will go, as "it" refers to the underlying. This is because the underlying has only three directions to go. If you can "predict" where it will not go, aren't you in essence predicting where it will go? If I predict it will not go up, aren't I also predicting that it will go sideways or down? This is what I meant by movement, in the same sense as one member posted that with many options strategies one only need be "sort of" right as to direction. By using the word movement, I was allowing for the fact that many strategies allow for multi-directional movement to make a profit. Btw, this is a great thread and I appreciate all the discussion that it has generated.
smilingsynic There are many options (excuse the pun). But if you're following the thread the debate is about adding a positive expectancy to what was initially a negative expectancy. The example cited does no such thing.
you're arguments are all very cogent and logical and i don't disagree or have a simple reply. but let me toss another thought (or half-thought) out. what if the intended position is ultimately the butterfly as riskarb has suggested. the position is legged over time by embracing an unknown but reasonably controllable set of risk factors with the intention to lay those risks off as the market permits or forces. it can be built any number of ways: buy the strangle first, trade the verticals initially, just buy or sell a single leg, etc. but the ultimate goal is the same: own a fly for less cost than current market value. each individual trade is a discreet negative expectancy event and as you imply can be looked at without regard or memory of what happened previously. but still the trader has retained these memories and in fact has planned to incorporate them into the ultimate position. so the relationship is now more complex. and indeed the sequence of trades and the history of what happened now has the utmost relevance. now put a twist on this. say i enter a trade randomly. after sometime the market has moved in one direction or another and any number of variables has changed. yet i have that initial trade and i now have to do something with it. i will seek to either close it or adapt it by incorporating it into a new position based on whatever is available to me now. i may or may not construct a butterfly. but the fact that i didn't have a plan initially does not negate the relevance of the past trade for my decision process. my goal is still the same: own something at a net cost less than current market price. i am not making predictions about the future exactly, i'm employing my skills and experience to set up moves that take advantage of possible scenarios. kind of like a master chess player that plans a move based on mentally rehearsing groups of potential sequences. maybe this is the definition of trader skill. the ability to adapt to circumstances using vehicles that in isolation are completely random negative expectancy events. it has nothing to do with having an opinion about the future but has everything to do with knowing the dynamics of options and managing their risks.
IV is irrelevant here. IV is only known AFTER the fact. What if the IV I paid on the adjustment was higher but then the next day the stock gapped down 30 pts and I make a killing. Then in reality, or in hindsight, I actually underpaid for IV substantially. The argument that a few of us are trying to make is we cannot determine at the time of entry if IV is high or low. That's completely subjective at the entry point. It's only after the trade is over we can look back and say, wow, that straddle was a good do at 3pts. Or man, that thing never moved after I bought that straddle. You may think you are locking in a profit by taking your profits and moving on to the next trade. But what you are really doing, is taking good money and throwing it after bad. The next trade you make is going to have a negative expectancy! I understand this topic is very confusing and we may never agree on this. But this is a great thread. I appreciate everyone's contributions.
you're buying? or selling? pretty hard trade. i wouldn't have done anything, but ebay was a missed opportunity for me after earnings, so i'm a little familiar with this situation. no straddle/strangle buying/selling for me before earnings, but i had a directional opinion on ebay (which I didn't take because i already had enough positions) after earnings. so, don't keep us in suspense too much, which one did you take?
if you have a decided opinion on a market, there are always ways to use the greeks to create the best reward/risk scenario if your prediction is right.
He bought the straddle. He wanted one side to have intrinsic value. The reason? He wouldn't have posted the trade were it a loser.