Option strategy buy Straddle / Strangle
Updated
In this post, I will start from the example and then write the definitions.
Our example will be on Boeing (BA), a hypothetical analysis might be that BA was trading sideways for more than half a year. Previous to that BA was down in price for more than 50%, also there was a rally of 100% between May and June. The volatility in the markets starting to rise, due to Covid-19, election, lockdowns, blue or red waves, vaccines, other news, etc. The trader expects a large move but doesn’t sure in which direction. Also, the rise in volatility enters into consideration, by our trader.
The trader search for a strategy that can be profitable in any direction and a rise in volatility will benefit him.
Straddle buying
A straddle purchase consists of buying both calls and puts with the same stock, option striking price, and expiration date. The straddle purchase allows the buyer of the options to make large potential profits if the stock moves far enough in either direction. The strategy has a limited loss and theoretically unlimited profit.
Buying a straddle should be done on stocks that have the potential to be volatile, this strategy is even more attractive if the options premiums are relatively low, which makes the straddle cost less and if the volatility will rise the buyer will profit much quicker. In general, the probability if held to expiration is near ~40%.
Most of the traders don’t wait till expiration. The options are At the money.
The example on the chart:
Blue lines – profit lines, yellow lines – break-even, red lines – 50% of maximum loss reached. Red zone – in this area the strategy losses money.
The options are from 30/10/2020 close in BA.
The strategy bought for -> 47.35, meaning a debit is being paid.
Stock price-> 144 , Upper strike (call)-> 140, Lower strike (put)-> 140
Days-> 203, Impleid volatility-> 54.4% (0.544), date-> 30/10/2020
The maximum loss is the debit paid for the strategy, in this case, $4735, the chance to lose all of it is less than 1%, the price needs to finish at expiration exactly at the strike price of the options $140, which means all the options will be worthless.
If the price will finish exactly at $163.69 a loss of 50% of the debit paid will occur, the puts will be worthless but the calls still have some value, but less value than the debit paid. If the price will finish exactly at $116.33 the trader will also lose 50% from the debit, but now the calls are worthless and the puts have value.
If the price will finish between $116.33-$163.69, a loss of 50%-100% from the maximum profit will be realized.
The prices of $92.65 and $187.35 represent the prices at which the strategy will break-even. At the lower price, the calls will be worthless and the puts will have value, at the higher price the other way around.
Those prices can be calculated:
Upper break-even point -> the strike price + the debit paid = 140+47.35=187.35
Lower break-even point -> the strike price - the debit paid = 140-47.35=92.65
The strategy presented on the chart has 147 days, before starting to lose 50% of the maximum loss (Debit paid).
If at any point the stock price will reach the dark blue line the strategy will profit $4735 if the light blue line will be reached the profit will be $9470.
How implied volatility affects the position? (20% increase and decrease)
20% IV increase -The buyer wants the implied volatility to increase, the strategy will start profit much sooner. The purple zone is the new loss area, the new area is much smaller than the previous one. The break-even lines are much closer to the end date and each other. It will take more time to reach the 50% loss lines 173 days instead of 147 days.
20% IV decrease – If the implied volatility will decrease, the purple loss zone will grow substantially, the break-even lines will go farther from one another and the 50% loss line could be reached much sooner, 63 days instead of 147.
Strangle Buying
A strangle is a strategy that uses both calls and puts, which have the same expiration date, but different striking prices. The difference between a strangle and a straddle is that the options are now Out of the money, because of that the strangle cost less than the straddle.
The example on the new chart:
Blue lines – profit lines, yellow lines – break-even, purple lines – 50% of maximum loss reached. Red zone – in this area the strategy losses money.
The options are from 30/10/2020 close in BA.
The strategy bought for -> 23.95, meaning a debit is being paid.
Stock price-> 144 , Upper strike (call)-> 190, Lower strike (put)-> 125
Days-> 203, Impleid volatility-> 54.4% (0.544), date-> 30/10/2020
Those options were chosen because they have a Delta of 0.3
The maximum loss is (-$2395) if the price will be at expiration between the strikes 125-190, the strategy will lose all the debit. (Broken red lines)
The other lines are the same concept as the straddle and their outcome is shown on the chart.
The break-even point calculation at expiration:
Upper break-even point -> the upper strike price + the debit paid = 190+23.95=213.95
Lower break-even point -> the lower strike price - the debit paid = 125-23.95=101.05
The strangle presented on the chart has 101 days, before starting to lose 50% of the maximum loss (Debit paid).
The increase and decrease in volatility will have the same effects, thus in the buyer analysis will anticipate an increase in volatility.
This post is related to previous posts.
You can come back and see what will happen with this particular example.
If you have any questions, please ask.
Our example will be on Boeing (BA), a hypothetical analysis might be that BA was trading sideways for more than half a year. Previous to that BA was down in price for more than 50%, also there was a rally of 100% between May and June. The volatility in the markets starting to rise, due to Covid-19, election, lockdowns, blue or red waves, vaccines, other news, etc. The trader expects a large move but doesn’t sure in which direction. Also, the rise in volatility enters into consideration, by our trader.
The trader search for a strategy that can be profitable in any direction and a rise in volatility will benefit him.
Straddle buying
A straddle purchase consists of buying both calls and puts with the same stock, option striking price, and expiration date. The straddle purchase allows the buyer of the options to make large potential profits if the stock moves far enough in either direction. The strategy has a limited loss and theoretically unlimited profit.
Buying a straddle should be done on stocks that have the potential to be volatile, this strategy is even more attractive if the options premiums are relatively low, which makes the straddle cost less and if the volatility will rise the buyer will profit much quicker. In general, the probability if held to expiration is near ~40%.
Most of the traders don’t wait till expiration. The options are At the money.
The example on the chart:
Blue lines – profit lines, yellow lines – break-even, red lines – 50% of maximum loss reached. Red zone – in this area the strategy losses money.
The options are from 30/10/2020 close in BA.
The strategy bought for -> 47.35, meaning a debit is being paid.
Stock price-> 144 , Upper strike (call)-> 140, Lower strike (put)-> 140
Days-> 203, Impleid volatility-> 54.4% (0.544), date-> 30/10/2020
The maximum loss is the debit paid for the strategy, in this case, $4735, the chance to lose all of it is less than 1%, the price needs to finish at expiration exactly at the strike price of the options $140, which means all the options will be worthless.
If the price will finish exactly at $163.69 a loss of 50% of the debit paid will occur, the puts will be worthless but the calls still have some value, but less value than the debit paid. If the price will finish exactly at $116.33 the trader will also lose 50% from the debit, but now the calls are worthless and the puts have value.
If the price will finish between $116.33-$163.69, a loss of 50%-100% from the maximum profit will be realized.
The prices of $92.65 and $187.35 represent the prices at which the strategy will break-even. At the lower price, the calls will be worthless and the puts will have value, at the higher price the other way around.
Those prices can be calculated:
Upper break-even point -> the strike price + the debit paid = 140+47.35=187.35
Lower break-even point -> the strike price - the debit paid = 140-47.35=92.65
The strategy presented on the chart has 147 days, before starting to lose 50% of the maximum loss (Debit paid).
If at any point the stock price will reach the dark blue line the strategy will profit $4735 if the light blue line will be reached the profit will be $9470.
How implied volatility affects the position? (20% increase and decrease)
20% IV increase -The buyer wants the implied volatility to increase, the strategy will start profit much sooner. The purple zone is the new loss area, the new area is much smaller than the previous one. The break-even lines are much closer to the end date and each other. It will take more time to reach the 50% loss lines 173 days instead of 147 days.
20% IV decrease – If the implied volatility will decrease, the purple loss zone will grow substantially, the break-even lines will go farther from one another and the 50% loss line could be reached much sooner, 63 days instead of 147.
Strangle Buying
A strangle is a strategy that uses both calls and puts, which have the same expiration date, but different striking prices. The difference between a strangle and a straddle is that the options are now Out of the money, because of that the strangle cost less than the straddle.
The example on the new chart:
Blue lines – profit lines, yellow lines – break-even, purple lines – 50% of maximum loss reached. Red zone – in this area the strategy losses money.
The options are from 30/10/2020 close in BA.
The strategy bought for -> 23.95, meaning a debit is being paid.
Stock price-> 144 , Upper strike (call)-> 190, Lower strike (put)-> 125
Days-> 203, Impleid volatility-> 54.4% (0.544), date-> 30/10/2020
Those options were chosen because they have a Delta of 0.3
The maximum loss is (-$2395) if the price will be at expiration between the strikes 125-190, the strategy will lose all the debit. (Broken red lines)
The other lines are the same concept as the straddle and their outcome is shown on the chart.
The break-even point calculation at expiration:
Upper break-even point -> the upper strike price + the debit paid = 190+23.95=213.95
Lower break-even point -> the lower strike price - the debit paid = 125-23.95=101.05
The strangle presented on the chart has 101 days, before starting to lose 50% of the maximum loss (Debit paid).
The increase and decrease in volatility will have the same effects, thus in the buyer analysis will anticipate an increase in volatility.
This post is related to previous posts.
You can come back and see what will happen with this particular example.
If you have any questions, please ask.
Note
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