Sunday, August 19, 2012

Range Bound Option Plays

Trading Range Limited Risk

Long At-The-Money Butterfly/Condor
  • A condor is like a "stretched out" butterfly with two different middle strikes rather than just one
  • Can be a relatively inexpensive option strategy that has limited risk and limited profit potential
  • The closer a butterfly is to expiration, the more it will react to changes in the stock price
  • A strategy used by professional traders for years because of its protective characteristics
  • For a long butterfly, you want the stock to stay near the middle strike
  • Time decay (positive theta) is your friend

Long At-The-Money Time Spread
  • Long back month call (put) and short front month call (put) with the same strike price
  • Maximum loss is limited to the price of the time spread, but can be greater in certain index options
  • This spread works best if the stock price stays right at the strike price
  • Implied volatility can change at different rates in different expirations
  • The position becomes more sensitive to changes in the stock price as expiration nears

Trading Range Unlimited Risk

Short Straddle / Short Strangle
  • Short call and short put at same strike (straddle) or different strikes (strangle) at same expiration
  • Unlimited risk to upside and downside (strike minus premium collected)
  • Profit potential limited to the price of the straddle or strangle
  • Break-even points are the strike plus and minus the value of the straddle, or high strike plus and lower strike minus the value of the strangle
  • Short both calls and puts make this very short volatility (vega)
  • Time decay (positive theta) is your friend
  • Not for the squeamish or risk-averse

Put or Call Ratio Spread for Credit
  • The most common ratio between short and long is 2:1
  • Ratio spreads have unlimited risk – monitor your position carefully
  • At expiration, greatest profit at the short strike price
  • Because the position is net short options, there is an increased volatility risk

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