Option Pit The Option Pit Method Straddle Strangles

Option Pit The Option Pit Method Straddle, Strangles, Long Gamma, VXX & UVXY Option Pit

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You Will Learn • • Basics of Straddle and Strangles Set up of each trade Setting up directional versions of each trade Management of straddles and strangles

Reminder of Gamma Buying • When movement is above IV • When IV is at near all time lows or recent lows – IV when it gets cheap enough it is almost always a buy

IBM

GM

Straddle • A long straddle is the purchase of a call and put on the same strike • Usually execute at the money – But does not have to be executed at the money

SPX

Straddle • A straddle is a trade that swaps unlimited return for a heavy lift in options purchased • In the example above the trader is paying over 32, 000 dollars in premium • In return if the SPX takes off in a direction or gaps up higher the trader will get paid handsomely

Straddle • In addition to the exposure to movement itself there is also exposure to perceived movement • If implied vol goes higher straddles do very well • So its not just movement, its expectations of movement that will help a straddle win – Best case straddle moves and expectations of continued movement increase

Straddle

Straddle Enemy’s • Time passing – Ever minute, hour, day kills a straddle – Like all insurance policies time passing decreases the policy value • Perception that movement is going to stop will also kill a straddle • Worst case: nothing happens and belief that nothing will happen increases

Straddle

Greeks • A straddle is: Flat Delta, Long Gamma, Long Vega • A straddle is: short theta • Movement helps, time hurts • We will discuss profit targets and management later on

Strangle • Buying of a call and put on different strikes • Tends to be around the money, also tends to be equidistant from ATM price • Does not have to be and can be set up directionally

Strangle

Strangle • Basically the same as a straddle in concept • Slightly different in execution and management • Trade still wants a quick move, wants perception of movement to increase dramatically • Time passing is a strangles enemy

Straddle V Strangle • The strangle cost significantly less than a straddle • However, because the strikes are often separated the movement needed is more severe • Because of this, we consider strangles more of a play in perception than actual movement • We also prefer them direcitonally

Notice the Vega Exposure

Directional Straddle • A directional straddle will be rarely used by traders but may have use in stock replacement trades • A trader buys a deep ITM straddle to get long the underlying • If the underlying falls, owning puts for next to nothing may soften the blow

ORLY

ORLY TANK

Directional Strangle • We use these a lot for low vol directional plays • Recall that we stated that strangles are especially sensitive to vega relative to a straddle given the cost • I can use this to my advantage when IV is especially low, or we hit conditions that make us want to be long gamma.

GS

GS IV

Situation • I think GS is going to go higher • However the stock has had its choppiness over the last month dropping and rallying significantly • I want long delta with protection and IV is dirt cheap

GS

GS

GS

Setting Targets • On a straddle or strangle the main goal is as follows: – Get out of trade as fast as humanly possible • Try to make 10 -15% tops on a straddle or strangle • If you are lucky you will get a gap – This means that you wake up the underlying has made a strong move and the trade is up nice dollars.

Dollars • It does not matter where the dollars come from take them and leave. • If you get a gap take the money and leave • If the stock moves around but you aren't making what you expect – IV is dropping – Too much time is passing • Actively manage the trade

Gamma Scalping • There are several ways to gamma scalp – One can sell the side the is winning and wait for a reversal (the range stock) – One can sell a further OTM option in the side that is winning • Delta and decay magment – One can sell the undelrying • Must have serious dough and belief in the price of the vega purchased

Same Trade 3 Examples • Lets look at how scenario’s can play out with the three approaches in the QQQ • We will also look at an approach we used in the SL • While gamma scalping sounds sexy, it is a last resort and trades set up under the right conditions should rarely need much scalping – Good trades tend to use scalp technique 2

Summary • Straddle and strangles are plays on movement and perception of movement • Straddles and more importantly strangles are great for directional purchases • Gamma scalping is a last resort

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