Last week we looked at the Greeks related to a covered call position. Theta was the star of that show, and if all went according to plan, the rest wouldn’t matter. “According to plan” meant that the underlying would move up or go sideways, but would not be above the call strike price at expiration.
Let’s look at another case, where all the Greeks play much more significant roles. This time we’ll consider a straddle, which is a long put and a long call at the same strike price, usually the at-the-money strike. This is a position we might think about if we believed that a stock was going to move a lot, but we had no opinion as to which way that movement would be. This might be our price outlook, for example, if the release of earnings was expected. Some stocks frequently provide earnings “surprises” that move the stock one way or the other. Another case might be an expected announcement about drug trial results for a biotech company.
Would the straddle be a good idea? The answer, as always in options or any other kind of trading is – it depends.
We need the trade to pay us back more than we pay for it. At first glance, we might think that a straddle would be a waste of time. Since call prices move in the same direction as the underlying, and put prices move in the opposite direction, do the two just cancel each other out? Is a straddle similar to betting on both black and red on the roulette wheel?
Not exactly. Imagine that we make two $10 bets on our imaginary roulette wheel, and that each could lose only our $10, but might win any amount. We’d be risking a total of $20, but we might get back $22, or $220, or $2200. That sounds more interesting, and worth looking into further.
In some ways, this is similar to our straddle, if we paid $10 each for the put and the call. If the stock price moves up a great deal, the call will make money; in fact a theoretically unlimited amount. The put would lose money in that case, but it can only cost us at most the $10 we paid for it. Same thing in reverse if the stock moves down (almost – the… Continue Reading
