Trying to Understand Option Strategy Straddle

[Fran8]

Hi

Im trying to understand the option neutral strategy straddle.

Investopedia defines straddle in the following manner:

"A straddle is an options strategy with which the investor holds a position in both a call and put with the same strike price and expiration date. This allows the investor to make a profit regardless of whether the price of the security goes up or down, assuming the stock price changes dramatically. "

My understanding is that is a neutral strategy, it does not matter if the price moves up or down, so far so good.

Everyone recommends to buy at the money put and calls for the strategy.

When you look at a option chain for a stock (please look attached file) either the put or the call has to be out of the money while the other is at the money.

Another thing is that you are supposed to buy the same strike and the same expiration. But when you purchased the same strike for the put and the call then you realized that the option has not the same delta (please see attached file "Chain Greeks"), so the options do not move the same.

The stock symbol that I use for the example is "CNP" and when I took the picture the price was 21,68, if you calculate the breakeven price for the call and the put using the same strike price in this case 21 and the same expiration in this case 10 days you realize that for the call the price only needs to move 1,2% upwards and for the put it needs to move 4,52% downwards to breakeven.

The strategy is suppose to be neutral and is suppose to make money if it moves up or down a lot, but what I see and I have check in many stocks and it happens the same is that the trade is skewed in one direction since the move upwards to be profitable is considerable smaller than the move that needs to make downwards, so is not very neutral.

By my understanding to be neutral it will need to have the same delta so the price of the options move the same which in this case is not, and the possibility of making money long or short should be the same which in this case is clearly not since for the call you only need a move of 1,2% to breaeven but for the put you need a much bigger move of 4,52% to breakeven.

Please could someone explained to me or tell me what Im getting wrong, I would really appreciated

Thanks

 

[options-george]

I will try to give just a brief answer and see whether that makes sense.

Yes, a straddle is a delta-neutral strategy. Yes, you are not concerned whether the stock moves up or down, as long as it moves. If it moves significantly in either direction you will make money. If it doesn't then you will lose money.

Without looking at the details, I believe the reason why the deltas and the % moves required are currently not equal, is simply because the stock price is currently not at the strike price.

At a price of $21.68, the call will have intrinsic value of $0.68. Additionally it should also have time value. We can look at the put's price to estimate the time value, since the all of the put's value must be time value, since it has zero instrinsic value (i.e. it is OTM). Thus, the time value is about $0.25. If you add $0.25 to the call's intrinsic value, then you get $0.83 (which is right in the middle of the bid-ask spread of your quotes).

If you were to check the price when CNP is $21, then both the put and the call should have the same price (and both will have only time value)and should both have a delta of 0.5.

Does that make sense?

 

[Fran8]

So basically the call and the option will only be equal at the 21.

But still the strategy has more options of being profitable on the long side that on the short side,

or beacuse the put starts to get into the money it will move faster and the difference is compensated?

 

[Alessiop]

I will try to give just a brief answer and see whether that makes sense.

Yes, a straddle is a delta-neutral strategy. Yes, you are not concerned whether the stock moves up or down, as long as it moves. If it moves significantly in either direction you will make money. If it doesn't then you will lose money.

Without looking at the details, I believe the reason why the deltas and the % moves required are currently not equal, is simply because the stock price is currently not at the strike price.

At a price of $21.68, the call will have intrinsic value of $0.68. Additionally it should also have time value. We can look at the put's price to estimate the time value, since the all of the put's value must be time value, since it has zero instrinsic value (i.e. it is OTM). Thus, the time value is about $0.25. If you add $0.25 to the call's intrinsic value, then you get $0.83 (which is right in the middle of the bid-ask spread of your quotes).

If you were to check the price when CNP is $21, then both the put and the call should have the same price (and both will have only time value)and should both have a delta of 0.5.

Does that make sense?

Equity puts are usually more expensive than calls (i.e. if stock is trading at 22, the 22 put will be a bit more expensive than the 22 call)
I agree with all the rest, also I think that individual premiums are relatively not that important but should be considered as a whole, as the bet of this strategy is not where the market goes but how, i.e. you are buying volatility.

PS about the specific example made by Fran8, unless expecting big moves in the next days I wouldn't buy a straddle with only 10 days to maturity, but this is just my perception

 

[Fran8]

No Im not planning to buy, I just want to know the mechanics

 

[Fran8]

what about using the same strategy but buying a call out of the money and a put out of the money by one strike?

 

[options-george]

So basically the call and the option will only be equal at the 21.

But still the strategy has more options of being profitable on the long side that on the short side,

or beacuse the put starts to get into the money it will move faster and the difference is compensated?

It has a higher probability of profit on the long side only because price is currently trading above the strike price.

Also see Alessiop's comments re small differences in puts/calls re equity options. Alessiop is this because of dividends?

 

[options-george]

what about using the same strategy but buying a call out of the money and a put out of the money by one strike?

Yip, you could do that. Technically, this is referred as a "strangle", rather than a "straddle".

 

[Alessiop]

what about using the same strategy but buying a call out of the money and a put out of the money by one strike?

that's a Strangle, same principle, same type of bet (very low price exposure) but less expensive than a straddle (but less sensitivity to volatility change, so less profitable)

 

[Fran8]

that's a Strangle, same principle, same type of bet (very low price exposure) but less expensive than a straddle (but less sensitivity to volatility change, so less profitable)

I tought that once they got in the money the volatility was higher and the moves bigger and being out of the money less price sensitive so better reward

So a straddle will make more money than a strangle?

 

[Alessiop]

Alessiop is this because of dividends?

Hi
Equity puts are usually more expensive because they are used as protection against equity price falls, and as you may well know price drops in equity are statistically faster and 'heavier' than price rises.

For the same reason commodity call options are usually more expensive than put because statistically there is more need to get protection against commodity prices rises rather than price falls.

Usually FX put/call options tend to trade at the same level

 

[Alessiop]

I tought that once they got in the money the volatility was higher and the moves bigger and being out of the money less price sensitive so better reward

So a straddle will make more money than a strangle?

correct, if volatility increases the straddle will make more money

 

[Fran8]

Thanks to all for pinting me in the correct direction

 

[vanillaman]

Hi

Im trying to understand the option neutral strategy straddle.

Investopedia defines straddle in the following manner:

"A straddle is an options strategy with which the investor holds a position in both a call and put with the same strike price and expiration date. This allows the investor to make a profit regardless of whether the price of the security goes up or down, assuming the stock price changes dramatically. "

My understanding is that is a neutral strategy, it does not matter if the price moves up or down, so far so good.

Everyone recommends to buy at the money put and calls for the strategy.

When you look at a option chain for a stock (please look attached file) either the put or the call has to be out of the money while the other is at the money.

Another thing is that you are supposed to buy the same strike and the same expiration. But when you purchased the same strike for the put and the call then you realized that the option has not the same delta (please see attached file "Chain Greeks"), so the options do not move the same.

The stock symbol that I use for the example is "CNP" and when I took the picture the price was 21,68, if you calculate the breakeven price for the call and the put using the same strike price in this case 21 and the same expiration in this case 10 days you realize that for the call the price only needs to move 1,2% upwards and for the put it needs to move 4,52% downwards to breakeven.

The strategy is suppose to be neutral and is suppose to make money if it moves up or down a lot, but what I see and I have check in many stocks and it happens the same is that the trade is skewed in one direction since the move upwards to be profitable is considerable smaller than the move that needs to make downwards, so is not very neutral.

By my understanding to be neutral it will need to have the same delta so the price of the options move the same which in this case is not, and the possibility of making money long or short should be the same which in this case is clearly not since for the call you only need a move of 1,2% to breaeven but for the put you need a much bigger move of 4,52% to breakeven.

Please could someone explained to me or tell me what Im getting wrong, I would really appreciated

Thanks

You already have some great answers. I am an FX Options trader but the idea is similar to the stocks. Straddles are best run when there is news volatility and the market is going to blast. The issue with a straddle is, they are both at the money, so more premium cost also your nightmare is if the market goes flat, usually this soon sees both time and deduction of vega chew at you. If the market does move with a delta of 0.5 there is a 50% chance you finish in the money both Gamma and theta are sensitive to at the money Options so if the movement happens you will go in the money very quickly and you tend to get a bigger delta change.

I ran a straddle on Cable when all that inflation stuff hit well after a few hours I cut cut the call and stayed with the Put by the time the day ended the loss on the Call was forgotten. Glad to see there are a few Options traders here. Like to see more FX Vanilla Options traders, too many binary guys.

 

[stopdownlimitup]

I'm very new to options trading as well. I can't really answer any of your questions but my broker sent me this link and there's a lot of information about trading future options: https://www.cannontrading.com/tools/education-futures-options-trading-101

 

[ArianaTaylor]

Best Strategy

I am still working on understanding the strategy to trade into the binary options with using the services of Corporate options. It will help everyone for sure.

 

[marsman]

Hi, I can recommend the following online tool for testing the said option strategy, and countless many other strategies:
http://optioncreator.com/long-straddle
http://optioncreator.com/short-straddle

 

[moka2]

Does anybody do straddles with weekly Options ?
- Total cost is less than a monthly but it also means lot less time for the underlying to move in one direction
- What indicator one can use to back test and see the trading range of the underlying to see if it moves sufficiently in a week?

 

[SteadyOptions]

Straddles can be used successful on stocks before earnings. You buy them around 7-10 days before earnings and sell on the day on the announcement. Most of the time you can gain 10-15% either from IV increase or stock movement.

 

[Windlesham1]

check out our site-it's early days but there will be a lot of good stuff in addition each week http://optionsinvesting.co.uk/before-sharesthere-were-options/