Provest And Options
Buying Straddles
In this, the third article of the series, the strategy of buying a straddle is discussed, which gives option traders an opportunity not available to others.
AS discussed in the first article in this series, there are several key factors to consider in determining the best option trading strategy to use at any given point for a given security. Likewise, these criteria can be used to zero in on the specific best option or options to trade in executing a particular strategy. Selecting the proper strategy involves knowing what to look for in terms of the following variables:
- Probability
- Volatility
- Time left until option expiration
- The "skew" of implied volatility across strike prices and/or expiration months
- Timing of market price movement.
FIGURE 1: PROVEST OPTION TRADING METHOD CRITERIA. These are the primary factors and key considerations for the different criteria.In this installment we will look at a specific trading strategy -- buying a long straddle -- and how to use the Provest criteria to identify trading opportunities.
STRATEGY: BUYING A LONG STRADDLE
One of the most attractive features about trading options is the ability to create positions that you cannot create simply by trading a stock or a futures contract. If you trade stocks or futures directly, you essentially have three choices. You can buy long, sell short, or go flat. If you buy, that security price needs to go up in order for you to profit. If you sell short, that security price needs to go down in order for you to profit. And if you are flat, you hold no position at all and cannot make or lose any money.
With the use of options, you have other choices. For example, buying
a straddle -- simultaneously buying a call and a put on the same underlying
security -- offers unlimited profit potential if the underlying security
makes a meaningful move in either direction. The risk in this trade comes
if the underlying security fails to move far enough prior to option expiration
to offset the negative effect of time decay. What is primary to consider
when looking to buy a straddle is the fact that anything less than an above-average
movement in price by the underlying security may not be enough to generate
a profit on the trade.
...Continued in the March issue of Technical Analysis of STOCKS &
COMMODITIES
Excerpted from an article originally published in the March 2008
issue of Technical Analysis of
STOCKS & COMMODITIES magazine. All rights reserved. © Copyright
2008, Technical Analysis, Inc.
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