The Straddle Trading Strategy

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Contents

Straddle Options Trading Strategy Using Python

Introduction

The purpose of this article is to provide an introductory understanding of the Straddle Options in Trading and can be used to create your own trading strategy.

What Is Straddle Options Strategy?

How To Practice Straddle Options Strategy?

Types Of Straddle Options Strategy

Long Straddle

Straddle Options Strategy works well in low IV regimes and the setup cost is low but the stock is expected to move a lot. It puts the Long Call and Long Put at the same exact Price, and they have the same expiry on the same asset. This is unlike that in the Strangle options trading strategy where the price of options varies.

The strategy would ideally look something like this:

Straddle Options Strategy Highlights

It can be done by either of these methods:

  • In The Money Call Option
  • In The Money Put Option

Maximum Loss: Call Premium + Put Premium

Breakeven

At expiration, if the Strike Price is above or below the amount of the Premium Paid, then the strategy would break even.

In either case of Strike Price being above or below,

  • the value of one option will be equal to the premium paid for the options, and
  • the value of the other option will be expiring worthless.

It can be described as below:

  • Upside Breakeven = Strike + Premiums Paid
  • Downside Breakeven = Strike – Premiums Paid

How To Profit From Straddle Options Strategy?

Now, if the market moves by less than 10%, then it is difficult to make a profit on this strategy. The Maximum Risk materialises if the stock price expires at the Strike Price.

Implementing The Straddle Options Strategy

Traders benefit from a Long Straddle strategy if the underlying asset moves a lot, regardless of which way it moves. The same has been witnessed in the share price of PNB if you have a look at the chart below:

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Last 1-month stock price movement (Source – Google Finance)

There has been a lot of movement in the stock price of PNB, the highest being 194.65 and lowest being 117.05 in last 1 month which is the current value as per Google Finance and an IV of 18.25%

For the purpose of this example; I will buy 1 in the money Put and 1 out of the money Call Options.

Here is the option chain of PNB for the expiry date of 29th March 2020 from Source: nseindia.com

I will pay INR 16.05 for the call with a strike price of 110 and INR 8.30 for the put with a strike price of 110. The options will expire on 29th March 2020 and to make a profit out of it, there should be a substantial movement in the PNB stock before the expiry.

The net premium paid to initiate this trade will be INR 24.35 hence the stock needs to move down to 85.65 on the downside or 134.35 on the upside before this strategy will break even.

Considering the massive amount of volatility in the market due to various factors and taking into account the market recovery process from the recent downfall we can assume that there can be an opportunity to book a profit here.

How To Calculate The Straddle Options Strategy Payoff In Python?

Import Libraries

Call Payoff

The payoff should ideally look like this:

Put Payoff

Straddle Payoff

Short Straddle Options Strategy

Conclusion

In this article we have covered all the elements of Straddle Options Strategy using a live market example and by understanding how the strategy can be calculated in Python.

Next Step

Disclaimer: All investments and trading in the stock market involve risk. Any decisions to place trades in the financial markets, including trading in stock or options or other financial instruments is a personal decision that should only be made after thorough research, including a personal risk and financial assessment and the engagement of professional assistance to the extent you believe necessary. The trading strategies or related information mentioned in this article is for informational purposes only.

How to Use the Straddle Strategy When Trading Stocks

Volatility has returned to the market in a big way in the last two months.

The S&P 500 has waffled back and forth, and has crossed above or below its 50-day moving average seven times since the beginning of February.

In all of 2020, there were only nine such crossings.

Investors seemed to forget that the market moves in both directions. But the 11.7% drop in two weeks got their attention.

And just when it looked like the market was tanking on February 9, it made a big reversal and jumped 9.8% in just over a month. And now it has fallen again.

This seesaw action may have created opportunities for some investors, but it probably caused headaches for others.

With no clear pattern to work with, one-way bets on the market become more difficult.

But what if there was a strategy that could take advantage of the volatility? Would that be of interest to you?

What if the direction didn’t even matter … all you needed was the stock to move?

Straddle Strategy – You Just Need the Stock to Move Sharply 1 Way or the Other

One options strategy that can make money when volatility increases is called a straddle.

The strategy involves buying a put and a call at the same strike price, and then waiting for the stock to move. And you want it to move sharply.

Let me give you an example.

On March 12, Flex Ltd. (Nasdaq: FLEX) closed at $18.92. The $19 area looked like a resistance point, but momentum was definitely to the upside.

With some uncertainty about which direction the stock might move, I decided a straddle was the right way to go. The April 19 strike options made the most sense. They were at the money, and they weren’t going to expire for approximately five weeks.

At the time, the calls were $0.53 and the puts were $0.56. Buying both of them only cost $1.09, or $109 since the options represent 100 shares ($1.09 x 100 = $109).

For this strategy I had a target of a 50% gain, and that meant the combined value of the options had to get to $1.635.

Because the one side is going to be losing value while the other one is gaining value, it is realistic for the total value of the straddle to be provided by the one side.

In this case, I had targets for Flex of either $20.635 ($19.00 + $1.635) or $17.365 ($19.00 -$1.635).

I didn’t really care which target got hit. As long as one of them got hit, I was looking at a gain of 50%.

On March 23, Flex dropped down to a low of $16.66, meaning the April 19 strike puts had an intrinsic value of $2.34. And even though the calls didn’t have any value at the time, the straddle itself was still worth $2.34, and the straddle had a gain of 114%.

The arrow marks March 13, which is when I was looking to execute this trade. We see on the chart how Flex has experienced big swings in the last three months. Obviously the big swings in the market have affected it too.

But this is the exact type of stock you want to use to trade straddles. One that can swing 10% to 15% in a short period. With this straddle, I needed the stock to drop 8.2% or gain 9%.

Flex had four moves between 11.5% and 15% in a three-month period. This told me that looking for the 8% to 9% move was certainly a reasonable expectation.

2 Key Factors When Trading Straddles

Obviously, using a straddle on some stocks wouldn’t be a good idea.

As I mentioned before, you want volatile stocks when trading straddles. You are looking for sharp moves in one direction or the other. The worst thing that can happen when you are holding a straddle is to have the stock move sideways.

Range-bound stocks would not be good targets for using a straddle strategy.

The second thing you want is reasonably priced options. In the case of Flex, the premiums for the options were very reasonable compared to its recent moves.

If the premiums would have been higher, the straddle might not have been a good strategy. For instance, if the straddle had been $2 total, I would have needed $3 from the straddle to get that 50% gain.

Now, instead of targets of $20.635 or $17.365, my targets would be $22 and $16. The stock was at $18.92 when the trade was suggested. This means instead of an 8% to 9% move, I would need a move between 15.4% and 16.3%.

That seems like an unreasonable expectation, especially based on the previous moves for Flex.

So if you are going to use straddles during periods of higher volatility, make sure you choose stocks that move. And make sure that the options are priced so that it makes sense to use a straddle.

Ask yourself, does the needed gain or loss fall within the past moves?

Senior Analyst, Banyan Hill Publishing

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The Straddle Trading Strategy

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Options Straddle Strategies & Earnings Events: What Are the Risks?

Can straddles be used in an options strategy around earnings announcements or other market-moving events? Yes, but there are risks and other considerations.

Key Takeaways

  • A long straddle options strategy seeks to profit from a large price move regardless of direction
  • Straddles and other options strategies may sometimes be considered useful around earnings announcements, when volatility may be high
  • Know the risks of trading options around earnings reports, including the chance of a volatility crush

Some traders think a stock’s going to make a move, perhaps because of an earnings announcement or other upcoming event, then they consider buying a call option in case it goes up and a put option in case it goes down. This options strategy is known as a long straddle, and the idea is for the underlying to make a large move in either direction, so the straddle price expands beyond what was paid for it.

It might sound like a rational plan. But there’s a little more to consider.

Ways to Potentially Profit or Lose from a Long Straddle

Again, the idea of a long straddle is to gain from a large move without picking a direction. The position is created by buying an at-the-money (ATM) call and ATM put with the same strike price in the same expiration cycle. There are a couple different ways this strategy might see gains.

First, the long straddle could profit if the underlying stock moves significantly. If it moves higher, the call option may profit by more than the put option loses, potentially netting a profit after transaction costs. Conversely, the put option may outperform the losses from the call if the stock drops far enough before expiration.

It’s not just a matter of the stock moving, but also the magnitude of the stock’s movement. It needs to move far enough to overcome the price paid for the straddle, in addition to the transaction costs.

Another way long straddles can profit is if there’s a rise in implied volatility (vol). Higher implied vol can increase both call and put options prices, just as lower vol can decrease both the put and call prices (which would typically lead to a loss). Even if vol were to stay the same, the trade can lose, as option prices tend to decay with the passage of time.

So even if there is a rise in implied vol, it has to be a big enough difference to offset the time decay (“theta”) subtracted from both options. Vol and time decay, as we’ll see, can play a major role in whether a straddle is a winner or a loser.

Earnings announcements, or other known events (such as the introduction of a new product or ruling on a court case) are the types of events in which a long straddle trade might be placed. What’s important to keep in mind is that the straddle is pricing in the “normal” volatility days plus the heightened “event day volatility.” As you get closer to the event, there are fewer normal vol (lower) days, so the higher event day vol has more influence. This is why the implied vol usually rises leading into the event.

Beware the Vol Crush Post-Event

Holding on to a straddle through an event can be risky (see figure 1). Because volatility plays a big part in a straddle, it’s imperative that the straddle is bought at a time when vol is near the low end of its historical range. In figure 1, holding a straddle after the earnings announcements (marked by the red phone icons) could have been problematic if the post earnings move was not large enough to make up for the steep drop in vol. Notice how vol in the lower pane of the graph rose going into the earnings announcement, but regressed to its long term average following the event.

FIGURE 1: VOLATILITY AROUND EARNINGS ANNOUNCEMENTS. Volatility tends to rise ahead of a company’s earnings announcement and then tends to fall after the event has taken place. Data source: Cboe. Chart source: the TD Ameritrade thinkorswim ® platform. For illustrative purposes only. Past performance does not guarantee future results.

How Big of a Move Is Expected? See the MMM

Selling a Straddle or Iron Condor Ahead of Earnings

If you feel that the premium levels in the options are elevated enough to make up for a post-event move in the underlying, then selling a straddle ahead of the announcement might make sense. It’s important to remember, though, that selling a straddle entails open-ended risk. The maximum profit is capped at the strike, and it begins to erode the further the underlying moves away from it. Eventually, the profit turns to a loss, with no limitation on the upside. On the downside, the loss is capped only when the underlying stock goes to zero (see the short straddle risk graph below).

One potential alternative is a short iron condor. It’s a four-legged spread constructed by selling one call vertical spread and one put vertical spread simultaneously in the same expiration cycle. Typically, both vertical spreads are out of the money and centered around the current underlying price (see the iron condor risk graph).

The iron condor strategy is a favorite of many option traders as a way to take advantage of higher-than-typical implied vol, such as before an earnings release. Note that, unlike the short straddle, the iron condor’s risk is defined by the difference between the strike prices of the verticals minus the credit received when selling the iron condor. For example, if the verticals are $2 wide and the iron condor is sold for an $0.80 credit, the risk is $1.20 per contract before transaction costs.

The iron condor strategy is typically considered by traders who believe the current vol is elevated, they expect vol to drop once the news is out, and if they believe the price of the underlying will remain between the two short strikes in the iron condor (or at least close). But one reminder about an iron condor: This spread has four legs, which means extra transaction costs.

There’s no right or wrong way to play earnings and other company announcements; much depends on your objectives, risk tolerance, and the your view of the market. Long options straddles can be an effective way to trade the lead-in to earnings, but traders might also consider short options strategies going into the release. Just make sure you know and are comfortable with the risks involved.

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