 Sell Straddle Option Strategy
When the market has just made a dramatic move and you are
expecting it to consolidate - you might consider selling a
straddle. This strategy involves selling a call option and
a put option on the same asset at the same strike price and
expiration date. This gives you a known, but limited gain,
but does expose you to unlimited risk - so you must be
careful with this position and be confident of your
assumptions. It is not suitable for all investors.
With this strategy, your gain is composed of the
premium you received for the call and the put, less the
commissions.
When we sell a Straddle, the put and call that we
sell are normally on over priced options that are at-the-
money or close to it. We consider doing this after a
dramatic move in the market, when we are expecting it to
consolidate the move and digest its gains before moving
again. Because of the dramatic move that was made,
volatility is high, making the options we sell very
expensive. Then as the market consolidates, volatility
decreases and lowers the price of the options, increasing
our profits when we buy back the options at a lower price
to close our position. Decay also works in our favor with
this position.
But be ready to buy back one of the options if there is any
indication that the market will resume its trend or reverse
direction. If it looks like the market will trend up, buy
back the call; if it looks like the market will trend down,
buy back the put.
It is also important to cover risks and caveats of this
strategy.
The risk of this position is unlimited so you must be very
careful. Remember that the commission you pay for this
position will be higher because you are initiating two
related option transactions.
It is important to analyze your expectations for the
underlying asset and for the market before selecting your
strategy.
When you are analyzing potential option positions, it
helps to have a computer program like Option-Aid that
swiftly calculates volatility impacts, probabilities,
statistics, and other parameters of interest. These
programs can pay for themselves with the first trade that
they help you with.
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