Secret 30THE STRADDLE SECRET

A straddle is a form of option buying where you buy both a

put and a call on the same underlying stock or futures, both with

the same strike price and expiration month. Then the underlying

can move either up or down to win, and sometimes you can win

on both sides.

I am not usually a great fan of straddles because their price

tag is usually pretty high and you could be stuck with an expensive

option position. If the underlying stock or futures does not

move, you could take a beating.

However, if you can find a cheap straddle with plenty of

time, you could find a strategy with a high probability of generating

a profit, and that is very rare for a position where you have

limited risk. In other words, you cannot lose more than you paid

for the positions (the put and call).

For example, in 2001, one of my plays of the week in Ultimate

Option Strategies was a straddle on the stock, Terra Networks,

where you bought the Dec 7.5 call and 7.5 put. The

combined price of the two options was 1.5. This means that Terra

Networks would have to drop to 6 to break even (7.5 – 1.5 = 6) or

rise to 9 to break even (7.5 + 1.5 = 9).

To analyze this position, we ran a computer simulation to

determine the probability of one of our profit points being hit

during the life of the trade. This analysis is only possible through

computer simulation, and such simulation can be done on Option

Master® Deluxe software. Based on that analysis, we found

that there was a 80% probability of showing a profit some time

during the life of the options.

In addition, I looked at the charts and made sure Terra Networks,

an internet stock, had been an extremely volatile stock in

the past. In September of 2001, the stock dropped down to 5,

generating a good profit for the position.

Two internet programs that will help you find good straddles

are The Power Analyzer and The Option Research Scanner, available

at options-inc.com. Nevertheless, once you find what looks

like a good straddle, make sure you run a simulation on the

straddle and only enter such trades where you have an 80% or

better probability of profit. Most of the straddles I have recommended

over the years have been profitable, probably due to the

fact we only selected straddles with over an 80% probability of

profit.

 (We will cover simulations in a later chapter, and in the Option

Analysis section of the book.)

Finding a good straddle is only half the game. Taking profits

on such trades is your next challenge. Here apply the rules we

discussed previously. When you have a profit, scale out of positions

and set tight trailing stop-losses so profits won’t slip away.

Also, when you take profits on one side of the position, you may

wish to sell the other side if there is some option premium left.

A straddle is a form of option buying where you buy both a

put and a call on the same underlying stock or futures, both with

the same strike price and expiration month. Then the underlying

can move either up or down to win, and sometimes you can win

on both sides.

I am not usually a great fan of straddles because their price

tag is usually pretty high and you could be stuck with an expensive

option position. If the underlying stock or futures does not

move, you could take a beating.

However, if you can find a cheap straddle with plenty of

time, you could find a strategy with a high probability of generating

a profit, and that is very rare for a position where you have

limited risk. In other words, you cannot lose more than you paid

for the positions (the put and call).

For example, in 2001, one of my plays of the week in Ultimate

Option Strategies was a straddle on the stock, Terra Networks,

where you bought the Dec 7.5 call and 7.5 put. The

combined price of the two options was 1.5. This means that Terra

Networks would have to drop to 6 to break even (7.5 – 1.5 = 6) or

rise to 9 to break even (7.5 + 1.5 = 9).

To analyze this position, we ran a computer simulation to

determine the probability of one of our profit points being hit

during the life of the trade. This analysis is only possible through

computer simulation, and such simulation can be done on Option

Master® Deluxe software. Based on that analysis, we found

that there was a 80% probability of showing a profit some time

during the life of the options.

In addition, I looked at the charts and made sure Terra Networks,

an internet stock, had been an extremely volatile stock in

the past. In September of 2001, the stock dropped down to 5,

generating a good profit for the position.

Two internet programs that will help you find good straddles

are The Power Analyzer and The Option Research Scanner, available

at options-inc.com. Nevertheless, once you find what looks

like a good straddle, make sure you run a simulation on the

straddle and only enter such trades where you have an 80% or

better probability of profit. Most of the straddles I have recommended

over the years have been profitable, probably due to the

fact we only selected straddles with over an 80% probability of

profit.

 (We will cover simulations in a later chapter, and in the Option

Analysis section of the book.)

Finding a good straddle is only half the game. Taking profits

on such trades is your next challenge. Here apply the rules we

discussed previously. When you have a profit, scale out of positions

and set tight trailing stop-losses so profits won’t slip away.

Also, when you take profits on one side of the position, you may

wish to sell the other side if there is some option premium left.