Buying straddles

[Iqbal]

There are a lot of traders on this forum who sell options, I would like to start a discussion on actually buying straddles/ strangles as opposed to selling. Does anyone do this as their main form of trading ? what strategies do they use? Can it be consistently profitable?

I would appreciate any replies. Thank you in advance.

 

[Silent.Trader]

You may confidently assume that any option strategy is, in the long run, consistently losing due to transaction costs. According to options theory the only way to make money with options is with a trading strategy. You may of course disagree with options theory and insist that some options have a consistent edge. If you agree with options theory you have to know how to pick your entry and exit points. If you've no edge picking entry/exit points you've no edge trading options.

 

[garethb]

Iqbal

Buying straddles is not my main strategy but I have some limited experience. They look attractive as a strategy as "Whichever way the market moves I win". Silent trader is right no particular strategy in options has an inherent edge. This is just as true of trading futures or short to medium term stock trading. Buying has no particular edge over selling without taking a market view. In options this is more extreme due to the costs of dealing.

In buying a straddle the view you are taking is that the underlying will move one way or the other more than the market thinks it will and within the time constraints of your chosen contracts. Classic examples given are the run up to earnings or when big news is expected. But of course others in the market are capable of finding out when earnings anouncements will be. They will bid up the options prices prior to announcements. If they have not bid up the prices prior to an earnings release you have to ask yourself why.

Another consideration is to ask why you feeel this is a genuinely bi-directional opportunity. Straddles are expensive and fall alarmingly in value over time if nothing is happening. If you think the price is going to rise but you just want some cover in case perhaps it falls then I would consider just buying a call. You will loose less if the underlying just drifts down and you will get into profit much sooner if the underlying rises

As I say, I'm not the greatest expert on buying straddles and make most of my options money positioned the other way. But as a starter for 10 on what to consider in buying a straddle here are some ideas.

Have a clear view on when a sudden move is expected - what is going to be the catalyst for this - on what date will it happen. Why is your view it will happen better than the market

Buy when volatility is low -
Recent historic volatility lower than the longer term mean for the underlying.
Reduced volatility/congestion visible on the chart of the underlying.
Implied volatility low for that underlying both relative to historic actual vol and historic implied vol if that makes sense

Buy long enough before that the rest of the market has not already bid the price up. Buying low IV helps here. Don't buy so early that the time decay will kill you.

Choose an expiry such that the worst time decay will not have kicked in by the time your expected move is due. Should be at least a month left to expiry at the time of the earnings announcement (or whatever). If you choose too long an expiry however then any move in the underlying will have less impact.

Once the earnings or whatever arrive, if the underlyling has not moved for a day or two you will be facing a loss due to time decay. You still have time value however. Swallow the loss and get out. Don't hang around hoping that something else will come along to cause a big move.


Another approach for buying straddles is gamma scalping where you hedge with the underlying to keep delta neutral rather than take your money from a big move in one direction. You should make money if IV rises but I have never done it and expect for retail players the costs may make it hard to profit. I will leave that to one of the experts on the board to cover in more detail.

 

[Profitaker]

I agree the general gist of what Silent Trader is saying; namely that you need to take a view on the underlying. I would also add that (with options) you also need to take a view on Implied Volatility, as that will dictate whether you buy or sell an option given any directional view on the underlying.

Gareth has answered your question(s) far more eloquently than I ever could.

But just a few points on Time decay;

The flip side of time decay is Gamma. Perhaps the easiest way to think of Gamma is in terms of how much your Option will change in value for any given % move in the underlying. Time decay increases as expiry approaches, but so does Gamma. Time decay (theta) and Gamma both increase as expiry approaches. They are opposite sides of the same coin.

So if you want a big profit for your buck by short dated straddles, but you’ll pay for it in time decay, if you get it wrong. If you can’t stomach the time decay buy far dated straddles, but you’ll not profit as much given a big move in the underlying, though time decay will be more forgiving, if you get it wrong. It’s a trade-off.

Gamma scalping - Yes slippage is a factor, so you need a very liquid market. I use ESX options / Footise futures - typically roundtrip for 2 points including spread & Commission. Ideally you want lots of intra-day volatility. If you can make the daily rent (Theta) by delta hedging in the futures you're home and dry.

Good luck.

 

[Silent.Trader]

I agree the general gist of what Silent Trader is saying; namely that you need to take a view on the underlying. I would also add that (with options) you also need to take a view on Implied Volatility, as that will dictate whether you buy or sell an option given any directional view on the underlying.

I must strongly disagree with this. IV expectations do not dictate buying or selling an option. IV is just, and no more than that, another variable in the equation. If you're very confident about the direction of the move, but unsure about the timing selling is your thing as time will be on your side. If you envision an increasing IV this is no problem, time value is zero at expiration no matter how low or high IV.

Even if you envision a declining IV, you still should choose a long position if the most likely alternative scenario is a move in the opposite direction. E.g. a message is expected, you know the content will be a surprise and it will result in a price move. You may decide the chances of you being wrong is only small, you would not want to take the huge loss associated with being wrong with a short position.

Options trading is about deciding on the scenario you want to make money, deciding on the scenario you want to break even (the most likely alternative) and deciding on the scenario where you're willing to accept a loss. The more specific the prefered scenario and the bigger the area where you'll accept a loss the better the gains when proven right.

 

[Profitaker]

I must strongly disagree with this. IV expectations do not dictate buying or selling an option.

It does where I come from. I think you'll find that most serious Options books advocate the same.

 

[Silent.Trader]

It does where I come from. I think you'll find that most serious Options books advocate the same.

I don't know of a single option book that claims that IV expectations dictates the choice between a long and a short option. But maybe all the books I know are off the less serious type. Virtually every investment book I know however advocates prudent risk management. But off course you're completely free to take ridiculous risks.

 

[garethb]

If you buy a straddle then you are anticipating a move either way. If IV is high then the expectation of that move has been identified by others and is already priced into the market. If you buy a straddle at that point you will not make money unless the move experienced is even greater than that which is priced into the market. I do not advocate that if IV is high you should sell a straddle even though you expect a significant move, although if you are convinced the move will not justify the high IV then that would be a viable approach. My suggestion is that even though you expect the move, if IV is high you should ignore the opportunity and look elsewhere.

It is similar, perhaps, to the current price of oil. If somebody wakes up now and realises that global demand for energy is strong and decides oil or oil companies are a good investment then it could be that for the forseable future demand is priced in and there is little upside. This does not mean it is the right time to take a short position. (not a personal view on oil by the way, just trying to illustrate that just because you do not believe a proposition does not mean you believe the opposite of the proposition).


Best Regards

 

[Profitaker]

Silent Trader

Name the Options book and I'm fairly confident I can give you a reference wrt buying / selling IV.

In buying (selling) volatility the underlying price has to move more (less) than the price of that volatility to make a profit. Is that correct ? If so, then.

IV expectations do not dictate buying or selling an option

must be incorrect.

I agree your point wrt risk management.

 

[Silent.Trader]

Name the Options book and I'm fairly confident I can give you a reference wrt buying / selling IV.

I´m travelling at the moment so can´t tell you what exact editionjs I´ve read, but I´m confident that Hull and McMillan don´t make statements that justify yours.

In buying (selling) volatility the underlying price has to move more (less) than the price of that volatility to make a profit. Is that correct ? If so, then.
[/b]
must be incorrect.

I agree your point wrt risk management.

This is a complete rediculous discusion if you ask me. It´s very simple a declining volatility can never be the only reason not to forego the limited risk strategy (buying) for an unlimited risk strategy (selling). IV is no more than another variable in the risk/reward equation. Consequently IV does not _dictate_ your choice for buying or selling. I don´t see how you can agree with my risk management point and still stick to your opinion that IV expectations dictate whether to operate on the buying or selling side.

 

[RUDEBOY]

Look folks, the last time i bought a saddle i was 8 stone and riding a horse called 'Temptme'. Anyway, i'm 17 stone now, and couldn't straddle a saddle if you asked me. Cause i'm only 5'2"! Hope this helps?

Don't take the you know what!

 

[Profitaker]

This is a complete rediculous discusion if you ask me.

I can agree that, so I’ll make this the last ridiculous post on the subject.

It´s very simple a declining volatility can never be the only reason not to forego the limited risk strategy (buying) for an unlimited risk strategy (selling).

What’s limited or unlimited risk got to do with IV ? Who said anything about selling or buying options naked ?

IV is no more than another variable in the risk/reward equation.

You won’t last very long without a healthy respect for IV, IMHO.

Volatility (implied) is what we buy, and it’s what we sell. I buy volatility if I think it’s cheap and sell it if I think it’s expensive. Very odd strategy, don’t you think ?

Consequently IV does not _dictate_ your choice for buying or selling.

Strongly disagree. You can be bullish on the underlying, but IV should dictate how you trade the bullish view, with options.

I don´t see how you can agree with my risk management point and still stick to your opinion that IV expectations dictate whether to operate on the buying or selling side.

Well, let’s review your risk management point;

Virtually every investment book I know however advocates prudent risk management.

Yep, still agree your risk management point.

Cheers.

 

[Silent.Trader]

What’s limited or unlimited risk got to do with IV ? Who said anything about selling or buying options naked ?

Isn´t this thread about straddles? I know only two ways to trade them, long or short.

 

[A Dashing Blade]

Here's my take on it

If you buy a straddle to close the position you've either got to close it out in one go (ie sell the straddle) of leg out of it (ie sell each leg individually at different times)

With the former, unless you've had an explosive move in the underlying then you're unlikely to make money

With the latter, unless the underlying reverses pretty sharpish after closing the first leg (leaving you with a time decaying asset remember), you're also unlikely to make money.

Now, the pro's (ie market makers), do the opposite. Their essential stratagy (and I know I'm oversimplifying so no flaming please!) is to sell the atm straddle (ie sell the most time value) capping this position (in case of an explosive move) by being long otm calls and puts (ie a short butterfly).

In my opinion, simply buying straddles looking to sell them at a later date with no other trades involved will quite quickly blow you out of the water.

 

[Robertral]

I don't know of a single option book that claims that IV expectations dictates the choice between a long and a short option. But maybe all the books I know are off the less serious type. Virtually every investment book I know however advocates prudent risk management. But off course you're completely free to take ridiculous risks.

Then you clearly have no idea how an option book operates in the real world......

Risk Manager: "Your 100K over your vega limit!!!"
Me: "Yeah but Slient.Trader says that vol doesn't really make a difference to my PnL so I didn't bother looking at my Vega positon as it's just a variable in an equation that doesn't effect me as an options trader"
Risk Manager: "Oh right...clear your desk plaese"


The use of straddles totally depends on how you operate your book.. If I want to buy in some Vega in month X then I will buy an ATM strad, but if I want to dump some I might sell an ATM strad.

I can see where people are comming from just selling strads (most time value) and is prob an ok idea at the moment..

 

[Silent.Trader]

Risk Manager: "Your 100K over your vega limit!!!"

That you apparently have a riskmanager to tell you your exposure pretty much tells it all I guess.

 

[Robertral]

That you apparently have a riskmanager to tell you your exposure pretty much tells it all I guess.

Ermmm ok.....What are risk managers employed to do?

 

[A Dashing Blade]

That you apparently have a riskmanager to tell you your exposure pretty much tells it all I guess.

They're there to tell you when you're approaching / have breached your limits

 

[Robertral]

They're there to tell you when you're approaching / have breached your limits

Thank you

 

[Silent.Trader]

They're there to tell you when you're approaching / have breached your limits

That´s what i mean... I _know_ when I approach my limits, I _anticipate_ on market action to prevent breaching my limits, I don´t need a riskmanager to tell me!