Sunday, August 19, 2012

Volatile Limited Risk Option Plays

Long Straddle / Long Strangle
  • Long call and long put at same strike (straddle) or different strikes (strangle) at same expiration
  • Unlimited profit potential to upside and downside
  • Loss limited to the cost 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
  • The definitive position for volatile markets
  • Time decay (theta) is your enemy
  • The technique called "gamma scalping" can be used with straddles and strangles to offset time decay

Back Spreads
  • Long more options than short options
  • Unlimited profit potential with limited risk
  • This position has net long options, and is long volatility (vega)
  • Be aware that a backspread can be initiated for a debit (pay for it) or credit (receive money for it)
  • Sluggish stock price movement and time are your enemies

Short At-The-Money Butterfly / Condor
  • This position looks like a long straddle or strangle with the unlimited profit cut off where the short strike prices are
  • Profit will be limited to the sale price of the butterfly, loss limited to difference between the first two strikes minus the sale price
  • The closer a butterfly is to expiration, the more it will react to changes in the stock price
  • Maybe not the best strategy for this scenario, but our option geniuses forced this copywriter to include it
  • The further the short ATM butterfly is from expiration, the less sensitive it is to changes in the stock price but the more sensitive it is to changes in implied volatility

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