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Ray,
In your response to Peter's question, you responded that Peter's trade
would be "an uncovered straddle write" and parenthetically referred to it
as a strangle by another name.
These are two totally different option strategies. A straddle, by
definition requires that the trader take the same strike strike price for
the call and put; whereas a strangle means you're using different strikes.
The remainder of your comments on how to play the trade are clouded in that
it's not clear whether you are referring to a strangle or a straddle --
each which have a very different strategy for opening and closing.
G
Peter,
The trade you are describing is in fact a short strangle.
The advantage of opening the position after a strong run up in strike price
is the volatility will drive the premiums up which means you get more $$
when you sell the calls and puts on the open.
However, the basics of the trade you've described are extremely risky.
When you open a short strangle the objective is to keep all the premium
received when opening the trade. By setting the strikes on the puts and
calls near current market prices (as you indicated) will almost certainly
ensure the stcok price will move through the boundary in the short period(@
30 days)you're using.
Another consideration is to closely evaluate what has caused the stock to
have the significant run up. If it is solid news (or good eps) accompanied
by a run up in the market and sector, you may want to ask yourself whether
the stock price is likely to retrace during the time until expiration of
your position or to continue to run up strongly. If so, a short strangle
isn't the best strategy to apply.
In a short strangle, the major objective is to select a stock whose price
will move both up and down but stay within the boundaries of the put and
call strikes during the holding period. So volatility after opening the
trade is ideal, but it must be volatility within the range of your strikes.
Ideally you would select strike prices which allow sufficient room for that
stock to move (up and down) over time but without busting the boundaries.
The holding period should be based on a balance of higher premium for the
out months versus the expected market conditions.
Most of the short strangles we've traded are not held until expiration.
They are closed (on BOTH sides) when we have a >40% net gain on the trade.
This means we get to keep >40% of the initial premium deposited when the
trade is closed by buying both the puts and calls back at current prices.
To close only one side of the trade leaves you naked and at extreme risk.
Would strongly suggest you collapse the entire trade when closing, not just
one side.
Another thought for your consideration is that conducting a short strangle
on an equity is more risky than doing a short strangle on an index. This
is because individual stocks are much more likely to over react to good or
bad news sending the stock price spiking outside your strikes and forcing
you to close the trade or have the underlying common stock put to you or
called from you, whichever is the direction.
With an index short strangle which typically has a European style
settlement, you cannot get anything called from you or put to you until the
actual settlement date (expiration). This gives you the safety of the full
expiration period for the index to settle back within the boundaries of
your put and call strikes. Of course, even with a European style index,
you may choose to close the trade at any time during the expiration cycle.
Best of luck with your short strangles.
George T Selin
Option $trategies Inc
At 10:39 PM 1/30/98 EST, TRaffertu@xxxxxxx wrote:
>In a message dated 98-01-30 17:49:44 EST, peterq@xxxxxxxxxxxxx writes:
>
><< Would appreciate your comments on the following options strategy:
> 1. Choose a stock that has had a significant run up.
> 2. Volatility must be high.
> 3. Sell a strangle (sell call, sell put) such that breakeven range is
> -10%, +5%
> 4. Strike price near current market price.
> 5. Time to expiry atleast 30days. >>
>
> Hi Peter,
>
> The strategy you are describing is sometimes called an uncovered
>straddle write ( not as exotic as calling it a strangle, but more
>descriptive). It is a neutral position, meaning the writer has no strong
>opinion on the direction of the stocks movement and the stock is unlikely to
>move very much. It has limited profit potential and large risk potential,
>but can be profitable if the stock remains relatively unchanged at
expiration.
>Rather than run ups and high volitility, you should be looking for the exact
>opposit, a flat chart with low volity. The maximum profit occures if the
>underlying stock is unchanged at expiration.
>
> In a volatile market losses can occur very rapidly. The best
>stratagy to exit in this case is to buy back the in the money option when it
>reaches the price of the straddle and hold the other. There are other exit
>stratagies that involve buying a call(s) in a big up move or put(s) in a down
>move to limit the amount of risk.
>
> In general this is not a simple strategy and must be watched very
>closely. Before attempting it you should have a through understanding of
>options and what steps should be taken if the trade goes against you.
>
> Good luck and good trading,
> Ray Raffurty
>
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