|
Striking While The Iron Is Hot
Join Date: Jul 2004
Location: Hawkes Bay, NZ
Posts: 11,130
|
Straddle the Safest Strategy?
I received this enquiry from one of our members which I reproduce with permission:
  |
|
Quote:
Hi Wayne
You're an options man so I wonder if you'd mind answering a query. I'm relatively new to options and I've still got a lot to learn, but I've been going quite well with bought puts on US stocks. There's something I'd like to clarify. I've heard that the safest way to trade options is to buy a put and a call at the same time, i.e. a straddle or a strangle, effectively giving yourself a bet each way.
I can see the possible benefits of such a strategy if a stock is flat and there's an earnings report due and you're expecting it to jump one way or the other, but you're not sure which way. But surely the same strategy doesn't make sense if your stock is in a strong trend, has retraced briefly for a few days against the trend, and is now giving every indication that it's about to resume it's trend with a vengeance?
I mean, not only does it put your cost up considerably, but it also kills your profit to a some extent as one of the options would gain rapidly while the other one lost value rapidly (assuming that the stock does in fact make the expected trend resumption).
I guess you could unload the unprofitable one, but if the stock has made a decent move then the unprofitable option would already be showing a hefty loss which would eat into the profit of the other one. Furthermore, if you quit one of the options then it seems to me that you're removing your safety net if the stock was to suddenly reverse and move counter to the trend.
But on the other hand, would you really want to be in an option that was making money only because the stock was moving in the opposite direction to what you expected, i.e. against the trend? I mean, counter-trend moves tend to be short lived.
So, considering the above factors, my thinking is that just a single bought put is the best way to go if the stock is trending strongly but is currently retracing, yet showing sings of imminent trend resumption.
An example of what I'm talking about, the US stock BSC was downtrending strongly when it bottomed out on 9th January, then rallied for a couple of days before topping on January 11. The rally stopped near the Fib 38.2% retracement level, then BSC put in a small range inside day. According to my analysis, this was a good shorting signal if it traded below the inside day.
Now in this situation where the odds are heavily in favour of the stock resuming its downtrend, I can't for the life of me see any reason to buy a strangle or straddle, instead of just buying a single put. With just a single option, if it goes against me I can have a stop in place to minimise my loss. If it goes my way, it has the potential for considerable gains.
Is my thinking correct here, or am I, in my experience, missing something? I'd appreciate your views if you have time to give them.
|
  |
I get very annoyed when I see questions like this; not at all at the people asking the question, they are just trying to learn in what is quite a complicated subject. I get annoyed at the ersatz "experts" who spout rubbish like x is the safest strategy, or y is the best strategy.
There is no such thing as the safest or best strategy, there are only strategies that suit your market view, the way you like to trade and volatility conditions. The straddle and strangle are simply strategies for option traders to have in their armoury, to implement when they think it appropriate.
Bear in mind that just about any option strategy intrinsically contains a bet on volatility. This is doubly so with the straddle or strangle. The expected move in the underlying must be greater that that implied by the options price, AKA implied volatility. To see what can happen with regards to implied volatility in this instance see my post - Nike Straddle - Just Do It.
This illustrates my point about selecting strategies to suit your view and the way you like to trade. This trader has a clear scenario that he wants to trade and should it play out as envisaged, the straddle or strangle would be suboptimal. This trader wants a strategy with negative delta, not delta neutral like a straddle/strangle. This not to say that the straddle wouldn't suit another trader with a different view. It is a matter of understanding the strategy, the greeks, the risks, the potential reward, selecting and implementing a strategy that suits.
|
|
Quote:
I mean, counter-trend moves tend to be short lived.
So, considering the above factors, my thinking is that just a single bought put is the best way to go if the stock is trending strongly but is currently retracing, yet showing sings of imminent trend resumption.
An example of what I'm talking about, the US stock BSC was downtrending strongly when it bottomed out on 9th January, then rallied for a couple of days before topping on January 11. The rally stopped near the Fib 38.2% retracement level, then BSC put in a small range inside day. According to my analysis, this was a good shorting signal if it traded below the inside day.
Now in this situation where the odds are heavily in favour of the stock resuming its downtrend, I can't for the life of me see any reason to buy a strangle or straddle, instead of just buying a single put. With just a single option, if it goes against me I can have a stop in place to minimise my loss. If it goes my way, it has the potential for considerable gains.
|
|
In this instance, with this view, a simple bought put could be the ideal strategy to suit this view. The long put is short delta, long gamma, long vega, perfect for a strong down move. The risk is that IV was already quite high and should the stock go against the trader's position, there would be some volatility crush as well. If this risk is acceptable to the trader, perfect.
My view and not to be considered as advice yada yada yada.
Questions & additions welcome.
__________________
"You can observe a lotta things by watchin'" - Yogi Berra
|
24th-January-2008, 01:06 AM
Similar Threads
