Straddle / Strangle questions

[TraderNewb]

Hi everyone,

I've just started getting into straddles/strangles and have a few questions about them.

What should be the deciding factor when choosing to do a strangle or a straddle? Are there advantages to doing one versus the other?

Also, what is the best way to find these opportunities? If you know a company's going to report earnings how far out should you be buying the options? And, how many months should you have until the options expire?

I was reading a book that said you should buy options that expire at least 3 months from the "news event" (in this case earnings announcement) and you should by the options when the volatility is low (so at least 1-2 weeks before the expected news event). Is this information accurate? Are there better rules to go by?

Thanks for your help.

 

[overspool]

Quote from TraderNewb:

Hi everyone,

I've just started getting into straddles/strangles and have a few questions about them.

What should be the deciding factor when choosing to do a strangle or a straddle? Are there advantages to doing one versus the other?

Also, what is the best way to find these opportunities? If you know a company's going to report earnings how far out should you be buying the options? And, how many months should you have until the options expire?

I was reading a book that said you should buy options that expire at least 3 months from the "news event" (in this case earnings announcement) and you should by the options when the volatility is low (so at least 1-2 weeks before the expected news event). Is this information accurate? Are there better rules to go by?

Thanks for your help.

Strangle is a lot cheaper, but you need more movement. With a straddle you need less movement, but it is more expensive. Straddle is easier to hit your breakeven. A strangle is basically a poor mans straddle.

3 months or more will give you good time value, anything inside 30 days with deteriorate quickly. If im doing something like an earnings play, I will buy front month options two days before the announcement and do more of a momentum play. The book is probably thinking you will hold it for a while after the announcement to maximize profitability. So it depends on your style. IMO

 

[atticus]

Quote from overspool:

Strangle is a lot cheaper, but you need more movement. With a straddle you need less movement, but it is more expensive. Straddle is easier to hit your breakeven. A strangle is basically a poor mans straddle.

3 months or more will give you good time value, anything inside 30 days with deteriorate quickly. If im doing something like an earnings play, I will buy front month options two days before the announcement and do more of a momentum play. The book is probably thinking you will hold it for a while after the announcement to maximize profitability. So it depends on your style. IMO

Most hold duration thinking that there is no decay, but they're buying nil gamma and taking on a lot of vegas. I sold the GOOG Jan 710 LEAPS straddle when vols hit 44% and pulled >20 handles out of it in three weeks. Always run a chart of implied vol going back at least 6 months.

 

[overspool]

Quote from TraderNewb:

Hi everyone,

I've just started getting into straddles/strangles and have a few questions about them.

What should be the deciding factor when choosing to do a strangle or a straddle? Are there advantages to doing one versus the other?

Also, what is the best way to find these opportunities? If you know a company's going to report earnings how far out should you be buying the options? And, how many months should you have until the options expire?

I was reading a book that said you should buy options that expire at least 3 months from the "news event" (in this case earnings announcement) and you should by the options when the volatility is low (so at least 1-2 weeks before the expected news event). Is this information accurate? Are there better rules to go by?

Thanks for your help.

Oh, and just to clarify I was talking about long straddles/strangles. Seeing as how you said you were new I didn't think you were selling them...

 

[TraderNewb]

Quote from overspool
If im doing something like an earnings play, I will buy front month options two days before the announcement and do more of a momentum play.

Thanks overspool. That makes sense. But what are "front month" options. And, by buying them 2 days before earnings isn't the volatility really high? Do you sell on earnings day?

And, yes, they I am long.

Quote from atticus
Always run a chart of implied vol going back at least 6 months.

Thanks atticus, but where can I get one of these charts?

 

[atticus]

Quote from TraderNewb:

Thanks overspool. That makes sense. But what are "front month" options. And, by buying them 2 days before earnings isn't the volatility really high? Do you sell on earnings day?

And, yes, they I am long.



Thanks atticus, but where can I get one of these charts?

Bloomberg or free at www.ivolatility.com

 

[TraderNewb]

Thanks atticus!

 

[kinggyppo]

Your handle scares me a bit, I must say. I am not sure if you understand what these guys are talking about. Would you describe yourself as a new, intermediate, or advanced options player. What I am getting at is that options like futures are highly leveraged and time decay or theta is usually where a rookie can get burned if you are long. If you are long an at the money straddle time is your enemy as theta (think decay) will slowly erode.

Lets look at RIMM today as we have a perfect example of a (potential) profitable long straddle. RIMM reported earnings after hours. Players line up on both sides long and short depending on their outlook. RIMM closed at $107.00. The $106.625 strike is close. Let's say you were going to buy a dec $106.625 07 straddle. You would pay roughly $10.20 or $1,020 cash for the straddle, that is buy call/ buy put. Earnings come and presto RIMM rockets up to close at $118.99. $118.99 less the strike of $106.62 is $12.37. Theoretically you should be able to close the straddle for $12.37 - $10.20 = $2.17 or $217 per straddle. Again this assumes that RIMM opens tomorrow where it closed, I am trying to keep this simple. I don't know exactly where the options will open and I don't know where RIMM will open. I find it is more rewarding to follow a real world example than a musty example from a book. I also find that looking at profit or loss graphs helpful. You are asking some good questions.


http://finance.yahoo.com/q/os?s=RIMM&m=2007-12-21

http://www.theoptionsguide.com/long-straddle.aspx

 

[overspool]

Quote from TraderNewb:

Thanks overspool. That makes sense. But what are "front month" options. And, by buying them 2 days before earnings isn't the volatility really high? Do you sell on earnings day?

And, yes, they I am long.



Thanks atticus, but where can I get one of these charts?

Front month right now would be December. And yes its high, especially the day before the announcement.

If a company releases pre market I will sell that day. Honestly its probably not the best strategy because you really need a huge move to get your moneys worth.

Lately ive been going long calls or puts on no brainers. For example went long calls 2 days before Microsoft earnings. Its more cost effective. Put in like $500 and came out with a little over 2k. Bought at 10 contracts at $0.48, it opened that day at $2.10 way in the money. So I can be wrong 3 or 4 times and only need to be right once if I manage risk right.

Could have done the same thing with Apple, Google, ect. Limited downside, unlimited upside is where I try to stick my money. IMO

 

[forex-forex]

Quote from overspool:
Lately ive been going long calls or puts on no brainers. For example went long calls 2 days before Microsoft earnings. Its more cost effective. Put in like $500 and came out with a little over 2k. Bought at 10 contracts at $0.48, it opened that day at $2.10 way in the money. So I can be wrong 3 or 4 times and only need to be right once if I manage risk right.

MSFT wasn't a "no brainer". For over five years it was stuck in a very tight trading range, until the last earning report. I don't think anybody expected such a large move from MSFT.