Long Straddle Options Strategy – “Double and Quits”
Monday, November 3, 2008 at 12:36AM
Gold Prices in Other
The following is an options trading strategy that we have been considering, based on the long straddle strategy. We think it could be effective in these volatile times, so we are putting it forward for disscussion and would appreciate any comments that anyone has on the ideas, both positive and negative!

Theory


- Option contracts always have a certain amount of value in the market before expiration, regardless of price of underlying assets, due to the time premium built into a contract price
- In a volatile market, stocks jump about greatly, and therefore the calls and puts on these stocks jump around even more, often doubling in less than a month.
- If an equal amount of capital is put into a call and a put contract, which move inversely of each other, with the same underlying asset, then the volatility of the option prices means that one will rise dramatically when the other falls.
- If a combination of call and put options are selected that are volatile to the extent that one will double in around a month, then the option that doubles is sold, this reduces the traders cost adjusted risk to zero.
- The remaining (losing) contract is then sold on the market for whatever the current market price is, even if that price has decreased greatly from the original purchase price. The money generated from this sale is the profit on the trade.


Note: Since profit margin is small, trade must be designed so that the commission costs do not reduce net profit. E.g. buying 10 puts at 0.10 and 10 calls at 0.10 (total invested = $20. commission estimated $50) would incur large commission costs relative to the size of the trade.

Step by Step Theoretical Plan


1. Company, contract details worked out and trade identified.
2. Calls, Puts are bought virtually simultaneously on contract with expiration about 3 months away.
3. Immediately after, sell orders placed for calls and puts at double their purchase prices.
4. Once sell order is filled for one of the options, other option is sold at market to return the profit for the trade.

Note: If at any time the market value of both positions exceeds (by a decent amount) the initial capital placed in the trade, both positions can be sold before one doubles to return a (possibly smaller) profit in a shorter space of time. E.g. $10,000 in total is placed into the trade, and at a certain time the calls are trading for a value of $7500, and the puts have a value of $3000, then both posistion could be sold to bank a $500 profit.








Practical Example 1


Company: AEM – Trading at $50.00
Purchased October 2008 options on 15th August 2008
$10,000 invested over both positions.

AGNICO EAGLE MINES LTD COM OCT 18, 2008 $ 50.000 CALL
(Bought for $7.50. Sell order placed at $15)

AGNICO EAGLE MINES LTD COM OCT 18, 2008 $ 50.000 PUT
(Bought at $4.50. Sell order placed at $9)

AEM stock price was very volatile, and both options came very close to reaching their sells. Then:

On September 12th, the calls rose to (and later past) $15, which would have triggered a sell.
Calls Sold at 100% profit generating $10,000 in cash.
Gross Profit/Loss = Zero
Net Profit/Loss = -$75.00 (estimated commission costs of trade)

As soon as the calls were automatically sold at 100% profit, the puts would have been sold the same day at market.

The puts were trading at just over $0.80 that day.

Therefore the sale of the puts would have generated $888
Calls Sold at 84% loss generating $888 in cash.
Gross Profit/Loss = $888.
Net Profit/Loss = $813 (after estimated commission costs of trade)
Achieved in a month.

Long Stradle Options Strategy – “Double and Quits”


Practical Example 2


Company: AEM- Trading at $45.00
Purchased October 2008 options on September 10th 2008
$10,000 invested over both positions.

AGNICO EAGLE MINES LTD COM OCT 18, 2008 $ 45.000 CALL(AEMJI: OPRA)
Bought for $5. Sell order placed at $10

AGNICO EAGLE MINES LTD COM OCT 18, 2008 $ 45.000 PUT(AEMVI: OPRA)
Bought at $4. Sell order placed at $8.

AEM stock price gained in the next few weeks.

On September 16th, the calls rose pas $10, which would have triggered a sell.
Calls Sold at 100% profit generating $10,000 in cash.
Gross Profit/Loss = Zero
Net Profit/Loss = -$75.00 (estimated commission costs of trade)

As soon as the calls were automatically sold at 100% profit, the puts would have been sold the same day at market.

The puts were trading at $0.50 that day.

Therefore the sale of the puts would have generated $500.
Puts Sold at 90% loss generating $500 in cash.
Gross Profit/Loss = $500.
Net Profit/Loss = $425 (after estimated commission costs of trade)
Achieved in less than two weeks.

Long Stradle Options Strategy – “Double and Quits” 2


Downsides


No plan is perfect, and this one is certainly far from it with a number of downside risks.
The best way to explain the threats to the trade’s success is by the following scenarios that would result in substantial losses being made on the trade.

- The calls rise 99%, to just below the level where they would’ve been sold, before falling again and not reaching that level again before expiration.

- The puts rise 99%, to just below the level where they would’ve been sold, before falling again and not reaching that level again before expiration.

- The stock goes through a period of consolidation with limited volatility, neither the calls or puts rise to the level of the sell orders and the value of both contracts depreciates as the time premium is eaten away.

- The calls/puts double and are sold successfully. However for whatever reason there is no bid on the losing contract and therefore they cannot be sold.

What do you think of this strategy in the current market?

ALL comments are appreciated!



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