I can empathize with any new options trader trying to figure this out. Here are some points to help:
- Keep in mind that the option premium anticipates the future price movement of the tradeable (stock or ETF). That means the call option premium will be about as much as the price of the tradeable is expected to move up. If the option is priced below the historical price movement (IV< HV), that just means the tradeable price is expected to move less in the future. A low IV/HV ratio does <b>not</b> mean that the option is a bargain.
- Since you are trading a straddle for which you pay both sides (call and put), the price movement of the tradeable must overcome about twice the expected move implied by the option premium. This happens sometimes, but not most of the time. On average, you will have a net loss if you place this trade many times (assuming you hold to expiration).
- Generally, the option premiums on indexes is higher than individual stocks due to the convenience of indexes and higher demand. And price movement tends to be less for indexes than individual stocks because the net index movement is moderated by the average of its components. Taken together, these two points make the purchase of straddles on indexes a poor choice. You would be better off buying straddles on individual stocks which have lower premiums and a greater potential for larger price movement.
- You referenced a study showing that a straddle strategy can be successful with an exit when the loss reaches 10%. The risk here is that a string of consecutive losses will deplete your account quickly.
- You are using technical analysis to identify an inflection point to time your trade. That's a reasonable approach, but timing indicators are not consistently reliable. If you really had a good indicator for picking tops, I would say to just buy puts (not the straddle) and you would have a fair chance. But again, the notion of timing the market consistently is a beginners folly.
- You're probably not going to believe the negative nature of my comments above. You will likely press forward until you convince yourself. That is OK. Just trade very, very small positions until you reach your own conclusions. If you find consistency in success, you can always scale up later. If you find it doesn't work out as you hoped, you still have most of your account left.
- Keep in mind that the option premium anticipates the future price movement of the tradeable (stock or ETF). That means the call option premium will be about as much as the price of the tradeable is expected to move up. If the option is priced below the historical price movement (IV< HV), that just means the tradeable price is expected to move less in the future. A low IV/HV ratio does <b>not</b> mean that the option is a bargain.
- Since you are trading a straddle for which you pay both sides (call and put), the price movement of the tradeable must overcome about twice the expected move implied by the option premium. This happens sometimes, but not most of the time. On average, you will have a net loss if you place this trade many times (assuming you hold to expiration).
- Generally, the option premiums on indexes is higher than individual stocks due to the convenience of indexes and higher demand. And price movement tends to be less for indexes than individual stocks because the net index movement is moderated by the average of its components. Taken together, these two points make the purchase of straddles on indexes a poor choice. You would be better off buying straddles on individual stocks which have lower premiums and a greater potential for larger price movement.
- You referenced a study showing that a straddle strategy can be successful with an exit when the loss reaches 10%. The risk here is that a string of consecutive losses will deplete your account quickly.
- You are using technical analysis to identify an inflection point to time your trade. That's a reasonable approach, but timing indicators are not consistently reliable. If you really had a good indicator for picking tops, I would say to just buy puts (not the straddle) and you would have a fair chance. But again, the notion of timing the market consistently is a beginners folly.
- You're probably not going to believe the negative nature of my comments above. You will likely press forward until you convince yourself. That is OK. Just trade very, very small positions until you reach your own conclusions. If you find consistency in success, you can always scale up later. If you find it doesn't work out as you hoped, you still have most of your account left.