# Strangles, straddles and butterflies



## anne (23 July 2006)

Hi everyone

I've been reading up up long strangles, straddles and butterflies and would like to hear about any recent successful trades people have made using these strategies.

I'm interested in what was happening in the underlying stock to make you decide to enter the trade, what was the premium and exercise price  of the warrants or options you bought and  how long the trade took to close out and  at what price you closed out at.

Hope you don't mind sharing- -  the strategies certainly sound promising but are still a bit academic for me at the moment.  I think it would help to hear about real-life situations e.g "I bought  a strangle on the XJO just before Bernarcke was due to release his interest rate decision".

 It would be good also to hear about the duds!

Cheers Anne


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## wayneL (23 July 2006)

anne said:
			
		

> Hi everyone
> 
> I've been reading up up long strangles, straddles and butterflies and would like to hear about any recent successful trades people have made using these strategies.
> 
> ...




Anne,

The thing to remember with these strategies is that they are very much volatility strategies. Putting these on at the wrong time (volatility wise) can be suicide.

One must know their greeks to be successful long term with these delta neutral strategies.

Cheers


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## anne (23 July 2006)

WayneL,

have you ever done a successful strangle or straddle or butterfly and if yes, would you like to share the story with us?

Cheers Anne


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## wayneL (23 July 2006)

anne said:
			
		

> WayneL,
> 
> have you ever done a successful strangle or straddle or butterfly and if yes, would you like to share the story with us?
> 
> Cheers Anne




I do them from time to time if the conditions line up properly.

1/ Implied volatility must be in the lowest quartile of its recent range

2/ the stock price must be bang over 50 delta (slightly lower than the strike for stocks, right bang on top of the strike for futures {or very close to it})

3/ I'm expecting movement. Doesn't have to be all one way, can be back and forwards.

4/ The option must not be overvalued relative to statistical volatility

5/ The stock must have a spread that is normally very tight

I then delta hedge to lock in profits until theta starts costing too much.

As you can see the planets must all line up properly and opportunities are not there all that often. But when they do, I rarely lose.

Overall straddles are a loser if applied indiscriminantly. A good winner though if done properly.

What you are trading is gamma and vega predominantly. Theta is the killer as you are getting a double dose of it. You must have enough gamma and positive vega to overcome the effects of theta.

Cheers


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## anne (23 July 2006)

Thanks WayneL

It all still sounds   very academic to me.

 Would you mind describing your last favourite  recent successful trade using one of these strategies? Why you chose that trade, etc.

You don't have to if you don't want to, of course.

Cheers Anne


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## wayneL (24 July 2006)

anne said:
			
		

> Thanks WayneL
> 
> It all still sounds   very academic to me.




The underlying theory is academic and mathematical, and you can choose to learn options that way. But you don't need to. 

It is important to get a grasp of the greeks. A good way to do that is pictorially, using payoff diagrams. In other words, learning how these things affect your option trade using pictures. Thats how I finally grasped it. Do a search on option greeks on this site, there is quite a bit of material here.



			
				anne said:
			
		

> Would you mind describing your last favourite  recent successful trade using one of these strategies? Why you chose that trade, etc.




Here is a current one from my blog that has only been on a few days.

http://thevolatilityreport.com/volblog/nfblog/?p=70

and

http://thevolatilityreport.com/volblog/nfblog/?p=70

here is another one from a while back when I was toying with the idea of trading OZ

https://www.aussiestockforums.com/forums/showthread.php?t=2894&highlight=osh+volatility

Cheers


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## anne (24 July 2006)

Thanks WayneL,

but those examples don't seem to give enough detail (I don't think the first one (which seems to be identical to the second one!) is finished yet, is it?).

I found a couple of real-life examples by doing a google search - i'll see if i can hunt them down.

It always surprises me how difficult it is to find real-live case studies of all this theoretical stuff.

You'd think if strangles and straddles and butterflies were so great that people would be  doing them all the time - and boasting about them!

Since these strategies suit breakout situations - but where you don't know which direction the breakout will take, then I suppose the focus should be on what situations trigger those bi-directional breakouts in those stocks that you're limited to when doing options and warrant trading.

Cheers Anne


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## wayneL (24 July 2006)

That's the point I was trying to get across Anne.

They are promoted as a magic strategy by idiots trying to sell expensive courses. In reality they are but one technique that suit certain situations.

The problem with the "suits breakout" scenario, is that *everybody* is expecting the breakout. This causes a sometimes dramatic rise in IVs preceding the breakout and the inevitable volatility dump prior to the actual breakout... the exact opposite to what is intuitive and suggested by statistical volatility.

This makes the straddle *not* suitable for the impending breakout, unless you can get it on at low IV.

Charles Cottles latest book is titled "Options: The Hidden Reality" which should suggest something to you. i.e. most of the information on options is straight out BS.

If you don't mind me saying, you are expecting rather a lot from people to give precise information without charging for it. I'm afraid you will have to do some of the work yourself.   

Just go learn the greeks, it will be enlightening.

Cheers


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## anne (24 July 2006)

Hi WayneL

I didn't think I was asking for anything unusual.  People talk about their share trades all the time e.g.  "I bought ABC on open this morning because it got a sensational write-up in the newspaper.  I paid xxxc for it and it went to a high of yyyc four hours later. I sold 5c below its high for a profit of zzz%"

Who would charge or pay for that information?

For some reason, derivative trading is different - - lots of warnings, lots of theories and very little  discussion of actual trades.  And the information seems to get even skinnier once you move from the simple long warrant or option trades into the more exotic stuff.

I was reading up on the various options and warrants trades on the ASX site last night and my head was hurting.  

I thought,  "This is dumb:  you don't discuss the ins and outs of complicated trading strategies one after another and expect people to relate to it. It would be better to work from the other direction, which is the underlying stock situation,  a la Cazaly just before the WA govt announcement came through.  Good news would mean an explosion upwards; bad news would mean an explosion downwards.  

Someone could say: "How could I trade this and capitalise on the explosion regardless which way it fell.""

And of course the answer would be a straddle or a strangle or a butterfly - except of course those derivatives aren't offered on penny dreadfuls like CAZ!

So you are limited to the big berthas and the indices.  What situation could Woodside find  itself in that  could mean an explosion either way?  I don't know-  maybe a humungous oil prospect where success meant a jump of a few dollars and failure meant a fall of a few dollars.  Hard to imagine  big bertha Woodside being in that situation very often,  but maybe t happens occassionally e.g. one of the early Mauritania drills.

Across teh stocks where warrants and options are offerrred probably situations  happen often enough to perhaps warrant a strangle, straddle or butterfly a few times a year. i'm talking fundamental factors here rather than technical  factors. 

Take tomorrow for instance: BHP reports its quarterly result and it will say stuff.  Perhaps what it reports will trigger a mediocre explosion in either direction.

Or take the next day:  there may be an interest rate rise announced.   Neither of those events seem to be enough of a dead cert for a massive explosion to warrant a straddle,strangle or butterfly, but I'm watching anyway.

I am just curious  when other people have decided that one of those special situations justified going to the bother of entering that complicated trade.

Sometimes I think people in Australia don't actually do this sort of stuff - - instead they just read about the academic patterns in books and that's the end of it!

But I'm the eternal optimist -  so calling all  active straddlers, stranglers and butterfliers!!!

Cheers Anne


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## sails (24 July 2006)

anne said:
			
		

> ... You'd think if strangles and straddles and butterflies were so great that people would be  doing them all the time - and boasting about them!...



Hi Anne,

I think you have hit the nail on the head - straddles, strangles and butterflies are just like any other trading where there are no guaranteed profits - unfortunately there is no holy grail in options trading either.

As Wayne has pointed out, long straddles and strangles do best when IV levels are rising AND they do need a large move in the underlying.  So the trade-off for removing directional risk from a trade is theta decay and IV crush.

Butterflies (long or iron) are just the opposite.  It is easier to get a low risk butterfly when IV levels are high but you don't want the underlying to move.  Butterflies usually have a wonderful risk to reward, but the money is usually only made very close to expiry, so it's a bit like winning the lotto if you are lucky enough for the underlying to close right on your sold strike at expiry.  IOW, the trade off for the great risk to reward is low probability.

When starting out with options, it's a good idea to learn all these different types of strategies, how they work, where any extra risk might be hidden, which greeks are at work, etc.   After a while, one starts to combine strategies - perhaps start out with long calls and end up with a butterfly if IV increases.  

At the end of the day, all that option traders are doing is buying and selling puts and calls and using them something like a game of chess, taking advantage of the changing greeks as they are present themselves.

I've been pretty busy today, but over the next few of days I will see if I find a couple of examples from the Aussie market and post the risk graphs so you can at least get an idea and then follow those trades through.

Cheers,

Margaret.


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## anne (24 July 2006)

Thanks, Margaret

I'd appreciate that a lot.

i have since discovered a thread  where people do discuss their options trades so I'll read through that too.

One day i will try to understand the greeks, but I really do believe  in first things first - - and the first thing to get straightened out I reckon is to identify the right situation for a straddle, etc appearing in the underlying stock.

it would help to have a fundamental bent here! it would also help to understand what could possibly make a big bertha explode  in price - in either direction.

I think I will go look at a few big bertha charts and look for some explosions!

Cheers Anne


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## wayneL (24 July 2006)

anne said:
			
		

> Hi WayneL
> 
> I didn't think I was asking for anything unusual.  People talk about their share trades all the time e.g.  "I bought ABC on open this morning because it got a sensational write-up in the newspaper.  I paid xxxc for it and it went to a high of yyyc four hours later. I sold 5c below its high for a profit of zzz%"
> 
> ...




Anne,

I am quite insulted.

I and others have gone to considerable lengths to offer info on option trading for no reward. There are examples of such right throughout this forum and I spend hours per week doing this per week.

It takes a considerable amount of work to explain an option trade. When it is done and pointed to where it is, you whinge.

Sorry, if other people so desire to help you, fine. 

I won't be.

Ciao


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## sails (24 July 2006)

anne said:
			
		

> ... I didn't think I was asking for anything unusual.  People talk about their share trades all the time e.g.  "I bought ABC on open this morning because it got a sensational write-up in the newspaper.  I paid xxxc for it and it went to a high of yyyc four hours later. I sold 5c below its high for a profit of zzz%"
> 
> Who would charge or pay for that information?
> 
> For some reason, derivative trading is different - - lots of warnings, lots of theories and very little  discussion of actual trades.  And the information seems to get even skinnier once you move from the simple long warrant or option trades into the more exotic stuff....




Anne, I agree with Wayne that it does take quite a lot of time to type up posts on options and option trades.  Even my 150 or so posts, most of which are option related, have taken up a lot of my time.

They aren't as simple as share trading where you either just buy or sell the share and rattle off a few words to say what you have done.  The share has a constant delta of 1, no theta or vega to complicate it's pricing, only 1 leg to the trade, etc, so it is very different.

Straddles, strangles and butterflies are used for specific conditions which are identified by the greeks.  They are not a "one size fits all" and will lose money very easily if the conditions are not right.  I am sure this is another reason traders are not talking about them - the are not there all the time especially in the Aus market. 

Another reason you may find not too many get involved with Aus options is that we have huge fees here - not only the broker but $1.12 every time we trade an option contract to the ASX - and then there are the wide bid/ask spreads imposed by the MM's. If it weren't for the night shift, I would much prefer to trade options in the US and I know of many Aussies who refuse to trade the Aus market.

Hope this helps,

Margaret.


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## anne (25 July 2006)

Hi WayneL

I am sorry that I have offended you and I accept that you will not want to respond to any more of my posts.

i am obviously looking at warrant and option trading from a non-textbook point of view.  It doesn't seem that illogical to me, but perhaps I am wrong.  

It reminds me a bit of the old fundamental vs technical argument - only this time it is the "what influences the underlying  share price thing" vs greeks!

Maybe down the track, I will realise the error of my ways and acknowledge that with warrants and options, greeks are everything!

In my total ignorance today, though, I look at the warrant jbmwmb and wonder what good greeks will do me if I want to trade jbm using a warrant.

The problem I see is that there is only one warrant available for me to trade. It doesn't expire until  end of oct (light years away), the exercise price is $8.50 (share price is around nine bucks) and i get 3 warrants per underlying share.  

My biggest concern, and maybe it has a greek letter attached to it is the price Mr market maker will sell it to me - as today   it was just a lonely market maker and two  piddly trades worth $4000 each!

My choice therefore is to accept the price he offers to sell to me at any time or say "stuff it - - I'm not buying!"

My bigger concern is  deciding whether jbm, the underlying share, is likely to go shooting up. No greeks are going to help me much there!  but other things may influence jbm going up - e.g. maybe it is a lagging stock that follows the leading resource stocks up and down.  Who knows?

I just see jbmwmb as a very cheap jbm, without the risks  attached to cfds. i also see jbm as a waste of time buying as it is too big a slug for my liking, but I might be interested in buying it if I can get big, safe leverage on it.

I think this stuff is something I'm going to have to nut out on my own.  It is starting to make more and more sense.  I suppose I was just looking for a bit of stimulating company and ideas sharing. 

Thanks  though for taking the trouble to post what you did post.  Sometimes what I see as perfectly sensible questions don't seem that way to other people.

Cheers Anne


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## Bobby (25 July 2006)

sails said:
			
		

> Anne, I agree with Wayne that it does take quite a lot of time to type up posts on options and option trades.  Even my 150 or so posts, most of which are option related, have taken up a lot of my time.
> 
> They aren't as simple as share trading where you either just buy or sell the share and rattle off a few words to say what you have done.  The share has a constant delta of 1, no theta or vega to complicate it's pricing, only 1 leg to the trade, etc, so it is very different.
> 
> ...



Margaret,

Good post, should not have been passed over, many will see this !

Regards Bob.


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## professor_frink (25 July 2006)

anne said:
			
		

> Hi WayneL
> 
> I am sorry that I have offended you and I accept that you will not want to respond to any more of my posts.
> 
> ...





What exactly were you after here anne? You asked a question, Wayne not only gave you his exact criteria for putting on one of these trades(which is more than most people would have given out on an internet forum), but he also gave you a link(saving you the trouble of using the search function) to an example of one.

And instead of gratitude, you finish up with this-


> Thanks  though for taking the trouble to post what you did post.  Sometimes what I see as perfectly sensible questions don't seem that way to other people.




Maybe you should come back to this thread in a couple of months after you have put a few of these trades on indiscriminately and have been punished by the market for it. Then you may be in a position to listen to people who have offered to help you.

Wayne, Margaret- well done as per usual. Thank you for your posts


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## sails (25 July 2006)

Hi Anne,

WRT your JBM warrants - you need to ask yourself how much are you paying...  eg. how much is intrinsic (real) value and how much is extrinsic value... and then how is the value of extrinsic value made up...  By knowing these answers will help you to know how much risk you are taking on with the warrant or option.  Now I haven't studied warrants to the same degree as options, but they do share some things in common.  So below is my understanding of the warrant situation:

OK - so in the case of JBMWMB it is currently bid @ 42c and offered @ 42.5c and it has an spc of 3.  So you would pay $1.28 total for 3 @ 42.5c.  With JBM @ $9 and the strike price of $8.50, there is 50c of intrinsic value and and 78c of extrinsic value.

So it really is in your interest to know what is likely to happen to that 78c of extrinsic value.  As extrinsic value is predominately made up of theta (time), IV (volatility), and interest rates, it becomes obvious that most of this extra cost is due to high IV.

How will that affect your warrant?  What you want is for JBM to go up AND IV to at least stay steady - at best to increase.  However, if the IV component begins to drop, JBM can move up nicely and yet the warrant may not move much - or worse still actually lose money.

The bottom line is that if you don't understand the text book stuff on how these derivatives are priced, *it is quite possible to be right on direction and yet lose money on the option or warrant*.

Also, JBM goes ex-div at the end of August - you need to know how this will affect the warrant as well and I have heard that one needs to read the warrant specs to see how it is handled.

Your questions are simple to ask but very complex to answer!  These types of derivatives are mullti-dimensional, however when learned properly they can give a wider variety of trading opportunities than just trading stock alone.

Hope this helps!

Margaret.

PS - thanks Bob and PF for your comments   
Also, as I am not familiar with warrants, I have based the above on my understanding of options.  Magdoran, or any other warrant traders out there -please correct me if it is not right - thanks


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## RichKid (25 July 2006)

Firstly, thank you again to Wayne, Sails, Magdoran and all regular derivatives forum posters for sharing your time and genuine passion for derivatives. I for one do appreciate it, and although I may not post much on it due to my ignorance (although that hasn't stopped me posting in other threads!!) I do read what I can. 

I started some elementary studies of strangles and straddles using Wayne's guidance- it's all on this site and you really can learn it yourself if you put the effort in and show appreciation, but like most things in trading you can't become consistently profitable overnight. The more you rely on yourself to understand the concepts the more you will get out of it. The books mentioned in various threads will help too, most have worked examples.

As Wayne says, we do have to do some reading and research ourselves, I just consider myself fortunate to be able to read all the material that has been shared by people here on ASF. 

If derivatives don't suit some people then that's the way it is, it clearly works for many, there is no reason to disparage it just because it is not comprehensible to one. I don't trade derivatives much myself due to my trading plan but I do study it whenver I can with a view to more active trading in the future, I found the Aussie market is not too friendly in terms of liquidity and pricing (as mentioned in the earlier posts). 

It's also important to note the discipline that Wayne alludes to- if a trade doesn't match all his criteria for that strategy he doesn't take it, most of us mug punters would not have that level of understanding and self-control.

So thanks again to all those who share their knowledge and experience with such humility, you are very much appreciated, even by the lurkers and us novices, even though we may not thank you enough for it.


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## anne (25 July 2006)

Hi Professor Frink

The fault is all mine.  I asked a question that I assumed was easy to answer, and that in fact there would be heaps of answers to it,  but i was wrong. 


And I am grateful to Wayne for taking the trouble to try to answer my question.

And as you suggested, I am going to go away now for a  while and see if I can answer my own question. 

And thank you Margaret for all your helpful posts.

Cheers Anne


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## Magdoran (30 July 2006)

Hello All,


Just got back to Australia this morning… Hope everyone is well!!!

Thanks Richkid for the vote of confidence.

I agree with the respective comments from Margaret and Wayne.  We have spent years learning both the theory and the practice of various derivatives, and it is quite insulting for a beginner to drift in and expect it all laid out on a platter when we have all spent time and money (the cost of courses and books can add up substantially) to obtain the knowledge we have.

Also, since derivates are an involved subject, it is a minority who succeed here, and the professional derivatives personnel for institutions are paid in the hundreds of thousands (just think about the NAB currency option traders and their bonuses – before the scandal). Just look around at courses that are available and the prices attached.

The thing that amazes me is the arrogance of some people who breeze in assuming it’s all simple, and equate it to simply trading shares, ignore the core theories (on the “Greeks) judging these to be irrelevant, and somehow imagine that technical analysis approaches are somehow at odds with options theory. I would have thought both T/A and Options theory are incredibly important, and in fact almost inseparable if looking to trade successfully, (perhaps you could also add fundamentals here too).

Now, as for warrants (I too was insulted by a previous response on another thread – not happy about that either, so I’m with Wayne on this), I’ve commented on these that they are OTC (over the counter) instruments, and each has specific conditions – Margaret is quite right here.  But these instruments are also quite involved since there are different types, and just like with options, you have to know which instrument to choose for specific conditions, or know when NOT TO TRADE. There are also significant differences between warrants and options that I have covered previously in other threads…

Let’s say it again – derivatives are involved instruments, and require sufficient knowledge to use effectively.



Regards


Magdoran


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## doctorj (19 February 2008)

wayneL said:


> Overall straddles are a loser if applied indiscriminantly. A good winner though if done properly.



Apologies for digging up an old post wayne, I'm just curious what you mean by "indiscriminantly".

My interest in straddles has been piqued by a book on probability, psychology and randomness.  The author claims that people tend to overvalue current information and undervalue the black swan risk.  
The book isn't on trading, but is written by a trader.  Aside from being a prick, he's pretty strong on his views and has got me thinking about options.  But for a few units back in Uni, my experience with options is almost nil, so I'm interested in your feedback/experience on his strategy (follows).

Reading between the lines, I'm guessing he's primarily trading a long straddle (probably a fair way out of the money too) in circumstances where IV is relatively low.  I understand it's likely to lose money far more often than not, but what's your gut feel on the prospect for a strategy like this to have a positive expectency?  I doubt he's interested in trading breakouts, but more hoping to catch outliers.

To be honest, I'm not sure if I'm even asking the right question, so thanks for your patience.


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## wayneL (19 February 2008)

doctorj said:


> Apologies for digging up an old post wayne, I'm just curious what you mean by "indiscriminantly".



Doc,

If you just bought straddles every month, opening the next one as the last one expires, on a range of instruments/stocks, it would most certainly in the long term be a loser.

Why? Think about option pricing and what it attempts to achieve, bearing in mind there are two sides to every trade. If option pricing were totally efficient, straddles/strangles would essentially break even, whether long or short, again in the long term. However because of contest risk (bid ask spread and commish) they both become a loser.

With these strategies it is up to the trader to exploit inefficiencies and or pick favourable conditions for profit, scalp gamma/hedge delta.



doctorj said:


> My interest in straddles has been piqued by a book on probability, psychology and randomness.  The author claims that people tend to overvalue current information and undervalue the black swan risk.
> The book isn't on trading, but is written by a trader.  Aside from being a prick, he's pretty strong on his views and has got me thinking about options.  But for a few units back in Uni, my experience with options is almost nil, so I'm interested in your feedback/experience on his strategy (follows).
> 
> Reading between the lines, I'm guessing he's primarily trading a long straddle (probably a fair way out of the money too) in circumstances where IV is relatively low.  I understand it's likely to lose money far more often than not, but what's your gut feel on the prospect for a strategy like this to have a positive expectency?  I doubt he's interested in trading breakouts, but more hoping to catch outliers.
> ...




What the author is proposing (I presume it's Mr T?) is that WTFOTM (way the f*** out of the money) options are inefficiently priced and that the occasional black swan will hand the trader a handsome profit.

I'm not a mathemetician and don't have the skills to prove or disprove that, but it doesn't sound right to me in the real world of trading. It's a bit like placing your chips on 0 for every bet; a 1/37 chance, but you could be a waiting a heeeeeellll of along time for it to come up. Meanwhile your capital is being whittled away. 

In the real world, we don't know the probabilities or the payoff of such a strategy... that's hard enough to calculate with more conventional strategies

If it is Mr T, I think he's talking WTFOTM puts rather than strangles, as the black swan lurks to the downside only in stock indices, but don't know for sure.

Looking at the psychology of such a strategy, it's one hell of a long time between drinks. Could you trade this from 2003 till early 2008 without a substantial profit? Not this little black duck.

Caveat: I haven't read the book and could have the wrong end of the stick.


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## doctorj (19 February 2008)

Thanks for that Wayne.  I'll have to absorb your comments.  

You nailed the author in one.  I had considered the WTFOTM puts too, but I had assumed the premise he's working on was equally applicable on the upside and downside.

As for your comment about a straddle being a losing strategy, the way I'm interpretting what you've said is that options are always priced efficiently - wouldn't that make all option strategies losing?  Are you then suggesting that the nature options lends itself to having a toolbox of sorts you selectively apply, as opposed to a more mechanical strategy?


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## wayneL (19 February 2008)

doctorj said:


> Thanks for that Wayne.  I'll have to absorb your comments.
> 
> You nailed the author in one.  I had considered the WTFOTM puts too, but I had assumed the premise he's working on was equally applicable on the upside and downside.
> 
> As for your comment about a straddle being a losing strategy, the way I'm interpretting what you've said is that options are always priced efficiently - wouldn't that make all option strategies losing?  Are you then suggesting that the nature options lends itself to having a toolbox of sorts you selectively apply, as opposed to a more mechanical strategy?




No, not that they are always priced efficiently. The inefficiency is that a volatility projection is collectively made by the market. The market won't always get that right... but overall, the inefficiencies will cancel each other out if you trade every concurrent series.

Thus the goal of the long straddle trader is either.

1/ get a big move one way or the other, big enough to overcome the double time decay and any volatility crush if present. 

2/ Be long vega i.e. you are expecting a rise in option volatility (and movement)

3/ To scalp gamma

All three require some volatility projection skills and an understanding of what's happening with the greeks, in order to optimize the timing of entry/exit and which expiry to use etc.

There are setups that when they turn up, it's pretty hard to lose. Other setups that are almost certain losers.

Eg. If a long dated straddle is put on with option volatility at relative highs, you need a very large move for it to pay even considering the time the trader has given himself. Why? Vega risk and very low gamma.

If it goes quiet on you or even doesn't realize the volatility priced into the option, there will be a large loss (relative to potential reward).

***

What I'm really trying to say is that it's not an each way bet as promoted by the option education clowns. You have to know which of the greeks you are trading and which of the greeks are your risks, and pick the time when these are most suitable for what you have in mind.


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## shooter (31 March 2008)

Hi WayneL 

I've been paper trading on U.S. options. Since I'm not good at analyzing share movement. My main strategy has been either strangle or straddle type. I do realize that on top of all those criteria, how I buy call and put makes a significant difference on profit profile using Black Scholes model. Standard 1 call at X and 1 put at Y does not usually neutralize the delta unless (DeltaC = -DeltaP), and this makes the width of breaking even points to be greater than that of properly delta neutralized strangle or straddle in the early part of the game (first few weeks) and as a result, requires larger movemet of the underlying share price in order to profit.

I appreiciate the effect of volatility. In some of my positions, both call and put made money because of the increasing implied volatility. In this case, strangle and straddle type make more money than just a single long put or call. The vega risk is a lot higher for straddle type but also return can be higher when IV goes up. It is now very important for me to acquire a volatility projection skill. Is there any recommended reading material I should cover for this??? Please let me know, I much appreciate it. 

I ve been working on a closing strategy for this type of strategy. But it is kind of tricky. Also I m working on a strangle strategy that starts off with delta neutral and as the time passes by ( after 2 or 3 weeks), the loss region shifts away from the original share price so that it serves as a neutral strategy in the beginning and if it is all quiet for awhile the shift in loss region may help the share price to hit the profit region. 

Thanks for your time


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## wayneL (31 March 2008)

Hi shooter,

These are really good questions.



shooter said:


> Hi WayneL
> 
> I've been paper trading on U.S. options. Since I'm not good at analyzing share movement. My main strategy has been either strangle or straddle type. I do realize that on top of all those criteria, how I buy call and put makes a significant difference on profit profile using Black Scholes model. Standard 1 call at X and 1 put at Y does not usually neutralize the delta unless (DeltaC = -DeltaP), and this makes the width of breaking even points to be greater than that of properly delta neutralized strangle or straddle in the early part of the game (first few weeks) and as a result, requires larger movemet of the underlying share price in order to profit.



Great points, and really exposes the nonsense of the options spruiker's usual  schpiel on straddles/strangles. I only like them when all the planets line up correctly, then I rarely lose. But indiscriminate straddle buying is an almost certain loser over the long term.
Re delta neutral. Yep, you do want to truly neutral. You can do this a couple of ways.

1/ Only place the straddle on when it is neutral. In stocks, that is slightly below the strike. This is due to the cost of carry priced in to stock options.

2/ Use a synthetic straddle (using calls and short shares or visa versa) , creating delta neutral by adjusting the number of shares.

Other things to be aware of. Straddles/are a trade off of greeks. More time means less gamma, more movement needed to manufacture delta, more vega, less theta. Less time means more gamma, less movement to manufacture delta, less vega, but more theta.

Where you go in this regard depend are your view and exit/hedging strategy.



shooter said:


> I appreiciate the effect of volatility. In some of my positions, both call and put made money because of the increasing implied volatility. In this case, strangle and straddle type make more money than just a single long put or call. The vega risk is a lot higher for straddle type but also return can be higher when IV goes up. It is now very important for me to acquire a volatility projection skill. Is there any recommended reading material I should cover for this??? Please let me know, I much appreciate it.



I will eventually cover it in my site, but that's a way off yet. Sheldon Natenburg's Volatility and Pricing is probably the best though.

I'll say one thing, some of the standard dogmas are rubbish. The best thing IMO is the observation. Things to watch:

The volatility prediction capabilities of Implied volatility.
The cycling of volatility
The behaviour of IV approaching announcements; and immediatly afterwardss



shooter said:


> I ve been working on a closing strategy for this type of strategy. But it is kind of tricky. Also I m working on a strangle strategy that starts off with delta neutral and as the time passes by ( after 2 or 3 weeks), the loss region shifts away from the original share price so that it serves as a neutral strategy in the beginning and if it is all quiet for awhile the shift in loss region may help the share price to hit the profit region.
> 
> Thanks for your time



Don't quite know what you mean in the second part of this paragraph.


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## shooter (1 April 2008)

Hi WayneL

Thanks for the reply



wayneL said:


> 1/ Only place the straddle on when it is neutral. In stocks, that is slightly below the strike. This is due to the cost of carry priced in to stock options.




I usually do this; 
Suppose Nc and Np are the number of call and put options respectively, then they have to satisfy the following equation

Nc/Np= -DeltaP/DeltaC

If this is satisfied, the total delta for the strangle or straddle position is Nc*DeltaC + Np*DeltaP = 0 (* means times). In reality you can't make it exactly zero (due to the fact that Nc and Np are integers) but close to it.    




wayneL said:


> 2/ Use a synthetic straddle (using calls and short shares or visa versa) , creating delta neutral by adjusting the number of shares.




I like this strategy too. I only have tried with a long put and long stock. Only thing that I don't like about it, is the low leverage and small gamma. But theta and vega are smaller than straddle or strangle so I feel more comfortable openning the position longer. I prefer to use this after strangle or straddle makes money and lock the profit. Only the problem is when the current total delta is positive then I have to short sell shares and some securities I can't short sell them (it happened to me on optionsXpress virtual trading). Once it is locked, then I make an iteration of the process of waiting for the share price to move then lock the profit. 



wayneL said:


> Other things to be aware of. Straddles/are a trade off of greeks. More time means less gamma, more movement needed to manufacture delta, more vega, less theta. Less time means more gamma, less movement to manufacture delta, less vega, but more theta.




A great point!



wayneL said:


> Don't quite know what you mean in the second part of this paragraph.




Sorry for not making myself clear. It is much easier to explain with the theoretical plots I made, but it seems that I can only post pics with a URL address and currently unable to post them. I need find the way. 

Cheers for the good advice


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## wayneL (1 April 2008)

shooter said:


> I like this strategy too. I only have tried with a long put and long stock. Only thing that I don't like about it, is the low leverage and small gamma. But theta and vega are smaller than straddle or strangle so I feel more comfortable openning the postion longer. I prefer to use this after strangle or straddle makes money and lock the profit. Only the problem is when the current total delta is positive then I have to short sell shares and some securities I can't short sell them (it happened to me on optionsXpress virtual trading). Once it is locked, then I make an iteration of the process of waiting for the share price to move then lock the profit.



So you are gamma scalping, if I understand you correctly? Cool. The stock in the synthetic will help markedly.

The synthetic straddle will have identical greeks to the natural.

eg 5 x call + 5 x put 

is synthetically equivalent to

500 X STOCK + 10 x put

Regards to the margin required, if you're on portfolio margining, margin will be identical. If not however, you can create a hybrid natural/synthetic to soften the blow.

For example

200 x STOCK + 3 x call + 7 x put will be the synthetic equivalent of the above.

This will leave you enough shares to gamma scalp, while reducing margin compared to the "pure synthetic". Hows that for an oxymoron?


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## VolTracker (1 April 2008)

An alternative way to trade synthetics with greater leverage is to do the legs separately in an options a/c and a CFD a/c.

For example, instead of 50% margin in stocks with OX, you can get 95% on many ASX blue chips with Macquarie (still need a buffer for MTM vals).

Can be fiddly, with higher execution risk but worth considering especially with such high IV's currently.


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## shooter (1 April 2008)

Hahaha.. I didnt know it is called gamma scalping. I m still a newbie and I don't know many terminologies. I've been trying whatever the method that seem to work mathematically. Thanks WayneL. I ll investigate further on this technique.


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## wayneL (1 April 2008)

shooter said:


> Hahaha.. I didnt know it is called gamma scalping. I m still a newbie and I don't know many terminologies. I've been trying whatever the method that seem to work mathematically. Thanks WayneL. I ll investigate further on this technique.




Ron Ianeri put together a good intro video. have a look here: http://www.options-university.com/Videos/GammaTrading/

Contains sales spiel, but a good video imo.


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## shooter (2 April 2008)

wayneL said:


> Ron Ianeri put together a good intro video. have a look here: http://www.options-university.com/Videos/GammaTrading/




Yeh it is a good introduction. The guy in the video sounds enthusiastic for the solid 30 min.


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## sails (2 April 2008)

shooter said:


> Yeh it is a good introduction. The guy in the video sounds enthusiastic for the solid 30 min.




Yeah - the few times I have heard him, it's always the same.  Full marks for being passionate about his subject!

Ron took a session on "Volatility and Options Pricing" on ThinkorSwim's free Wednesday trader lounge on 12th March, 2008.  The archive is found on found on this page:  http://www.thinkorswim.com/tos/displayPage.tos?webpage=onlineSeminar&displayFormat=hide

BTW Wayne - good stuff on your site and so well set out.  Should really help budding option traders - will also follow it with interest


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## wayneL (3 April 2008)

sails said:


> Yeah - the few times I have heard him, it's always the same.  Full marks for being passionate about his subject!
> 
> Ron took a session on "Volatility and Options Pricing" on ThinkorSwim's free Wednesday trader lounge on 12th March, 2008.  The archive is found on found on this page:  http://www.thinkorswim.com/tos/displayPage.tos?webpage=onlineSeminar&displayFormat=hide
> 
> BTW Wayne - good stuff on your site and so well set out.  Should really help budding option traders - will also follow it with interest




Thanks sails. I'm relying on you to pick up any BS.


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## sails (3 April 2008)

wayneL said:


> Thanks sails. I'm relying on you to pick up any BS.




lol, definately not expecting any.  Only ever found one mistake and, if I remember correctly, that was only due to one small imput missed in Hoadley...  Wasn't even trying to check up - was only trying to understand the trade you had on!


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## shooter (3 April 2008)

wayneL said:


> I will eventually cover it in my site, but that's a way off yet. Sheldon Natenburg's Volatility and Pricing is probably the best though.




I forgot to ask. May I have a look at your site please? I am very interested!


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## wayneL (3 April 2008)

shooter said:


> I forgot to ask. May I have a look at your site please? I am very interested!



Just click on the link in my sig. I'm still going through the basics, but any questions, ask here on ASF.

Cheers


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## shooter (4 April 2008)

wayneL said:


> Just click on the link in my sig. I'm still going through the basics, but any questions, ask here on ASF.
> 
> Cheers




Looks like a great effort put into the site. I am looking forward to a further development. Please let me know if there is anything I can do to help. Probably only thing I can provide is 3D plots of Black Scholes equation. I have a maths software to plot the pay off curve with respect to strike price and time progression. Also I can plot all the greeks with respect to any of the variables, share price, strike price, volatility, interest rate, etc. The profile of pay off and greeks can be described by words but it might be helpful for the visitors of the site to visualize it in 3D.


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## wayneL (4 April 2008)

shooter said:


> Looks like a great effort put into the site. I am looking forward to a further development. Please let me know if there is anything I can do to help. Probably only thing I can provide is 3D plots of Black Scholes equation. I have a maths software to plot the pay off curve with respect to strike price and time progression. Also I can plot all the greeks with respect to any of the variables, share price, strike price, volatility, interest rate, etc. The profile of pay off and greeks can be described by words but it might be helpful for the visitors of the site to visualize it in 3D.




Yes that's exactly what I had planned as I get into the greeks etc. Thankyou for the offer, if I get into bother with images I'll certainly give you a yell. 

Cheers


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