wayneL
VIVA LA LIBERTAD, CARAJO!
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- 9 July 2004
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I received this enquiry from one of our members which I reproduce with permission:
It's a good question, and one that every options trader ponders as they go on their journey of discovery of this sometime bewildering trading instrument. There are a few concepts to deal with, perhaps if I cover with them one point at a time:
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.
My view and not to be considered as advice yada yada yada.
Questions & additions welcome.
It's a good question, and one that every options trader ponders as they go on their journey of discovery of this sometime bewildering trading instrument. There are a few concepts to deal with, perhaps if I cover with them one point at a time:
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.
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.