Long and Short ATM Straddles are Dead Money - But a very accurate indicator of future stock movement

[blueplayer]

Long and Short ATM Straddles are Dead Money - But a very accurate indicator of future stock movement.

1. Options are very efficiently priced by the MM's.
2. MM's do not reward money to lazy traders who want an easy buck without having to bother with due diligence.
3. Easy money would be buying or selling the ATM straddle - unless due diligence suggests the options are mis-priced.
4. ATM Straddles are most likely to break-even by expiring at the top or bottom range of the straddle.
5. The underlying trading range for the life of the ATM Straddle will most likely be Option Strike plus and minus the ATM Straddle Debit/Premium.
6. The underlying will most likely close on option expiry day at Option Strike minus ATM Straddle Debit/Premium OR Option Strike plus ATM Straddle Debit/Premium.

EXAMPLES USING REAL QUOTES

• SPY at $212.65.
• July 15, 2016 SPY 213.00 Call $0.88.
• July 15, 2016 SPY 213.00 Put $1.38.
• ATM 213.00 straddle $2.26.
• SPY trading range until option expiry $210.74 to $215.26.
• SPY closes at about $210.74 OR $215.26 on July 15, 2016. Unless the options are mis-priced.
• Both long and short 213.00 straddles expire at about break-even.

• GOOGL at $717.78.
• July 15, 2016 GOOGL 717.50 Call $5.70.
• July 15, 2016 GOOGL 717.50 Put $5.40.
• ATM 717.50 straddle $11.10.
• GOOGL trading range until option expiry $706.40 to $728.60.
• GOOGL closes at about $706.40 OR $728.60 on July 15, 2016. Unless the options are mis-priced.
• Both long and short 717.50 straddles expire at about break-even.

Comments are welcome.

I'm a full week late to the discussion, but here is my contribution, the cost of the ATM straddle is not really any indication of the implied 1 sigma move from option prices. It is a popular myth that the straddle is pricing the expected move until expiration, but that is incorrect. You only need to look at any theoretical framework to discover that. For instance in BSM, the cost of a perfect straddle (exactly at the money) with interest rates and dividends set to zero is:

Cost Straddle = 2*ATM*[F(sigma*sqrt(t)/2)-F(-sigma*sqrt(t)/2)]

sigma = implied volatility of ATM puts and calls
F(x) = Gaussian cumulative distribution function
ATM= the value of the at the money strike (which is also the value of the underlying at the same moment).
t = time to expiration.

As you can see the cost of the straddle is not providing anything useful right away. Although it could be used to extract the implied volatility of the atm calls and puts (solving for sigma) in the world where dividends and interests rates are zero but I'm not sure how useful that could be.

 

[J_Smith]

I for one, do not regret OG's very helpful thread

I take the points by BP, but I have already seen some advantage in using the data as OG put forward - not to try and predict where the market will finish btw!

It is another simple tool to add to your trading tool box, and as always, the simplest tools are always the best ones - we will always use a screwdriver for that important little job, no matter how many battery drills we have - fixing a mirror to a wall with a battery drill comes to mind!

J_S

 

[J_Smith]

OG, how do I put your thread forward for "thread of the year"

J_S

 

[Quiet1]

To be fair, it's only bollocks in the sense of eliding long run p&l expectation, in which case he's probably not that far wrong, and the p&l path over many trades that implies.
50:50 1:1 bets can take you very very far from flat...

 

[J_Smith]

Everyone has their own view - OG stated, correctly in my view, that, in the long run ATM straddles are dead money.

No one said anything about trading them, just using them to see what range the MM's are expecting till expiry, or maybe more exact, the software they use - if you look at the model price, based on TWS software, then the premiums can vary a nice bit with the model price.

Maybe I am as thick as 10 planks put together, but I can see value in what OG has presented, and am kicking myself in the ass for not thinking bout it in the past, when I traded index put and call options

OG, have you any more "snippets" - I am going to search tonite for a good TA setup to trade options, not sure what I will find, but I know I will find something interesting, as idiots who produce electronic documents think they are safe - which is far from the truth, even from thick idiots like me searching the web

J_S

 

[IronFist]

Below is a SPY Jan 20, 2017 215.00 ATM straddle (long or short) example that we can watch as it progresses.

• SPY at $214.92
• Jan 20, 2017 215.00 call (bid $7.78 ask $7.87 last sale $7.80)
• Jan 20, 2017 215.00 put (bid $9.40 ask $9.50 last sale $9.45)
• SPY Jan 20, 2017 215.00 ATM long or short straddle $17.45 (based on last sale)
• The MM's expect the SPY to trade from about $197.55 TO about $232.45 until Jan 20, 2017.
• The MM's expect the SPY to close at about $197.55 OR about $232.45 on Jan 20, 2017.
• During the next 6 months both the long and short ATM straddles will ebb and flow until expiry in which they most likely will expire at break-even.

The same applies to any equity/etf ATM straddle, GOOGL, GLD AAPL, FB, TSLA, etc. There will be some exceptions but the ATM long and short straddles are priced to break-even from the get-go.

Now you are saying you can predict where price will be on a certain day? I wonder if this can be used for different plans. Does this work for ATM value on any day or only on certain days?

 

[OptionGuru]

Now you are saying you can predict where price will be on a certain day?

The cost of the the ATM straddle predicts very accurately were the underlying will trade when the options expire. But there will be two quotes, a high quote and low quote.

You then can base a real trade around that info. You could even enter a long or short ATM straddle if you think the options are mis-priced.

Does this work for ATM value on any day or only on certain days?

Any day.

 

[J_Smith]

Well OG, you are not alone it seems - my search turned up a good pdf on options trading using TA, and this is a screenshot of a section.

What you described has another name - it is called the "expected move", which you more or less said anyway

Keep going, you are spot on, you Guru you

J_S