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>Selling straddles and outside combinations is a recipe for disaster.
>Limited profit and unlimited risk.
Agree wholeheartedly.
In the Tell Labs case today, shorting the common had the best return for
equal risk.
As a pure options play comparing short straddle with long puts, the return
was favorable to the straddle. This was conceptually signaled on the TLAB
chart.
Short straddle risk, as Ira says, is theoretically unlimited for predefined
maximum profit. There are exceptions, and there are time frames for trading.
Maybe I should have been more specific.
An update on how this played out today for Tell Labs, assuming one had no
idea where implied volatility was and was just trading off of price action:
Day trade:
Sell to open at open: Sep 60 call for $412.50 credit per contract
Sell to open at open: Sep 60 put for $400.00 credit per contract.
Buy at close to close: Sep 60 call for $332.50 debit per contract
Buy at close to close: Sep 60 put for $432.50 debit per contract.
Gross profit = $47.50 per contract.
If pre-open bias was bullish and the trader bought long $60 calls, the
trader would have a loss of $80 per contract.
If pre-open bias was bearish and the trader bought long $60 puts, the trader
would have a gain of $32.50 per contract.
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If the trader just went long stock at open, the trader would be down $218.75
per 100 shares (1 contract). Here the long call trade was less of a loser.
If the trader just went short stock at open, the trader would gain $218.75
per 100 shares (1 contract). Here the long puts trade was less of a winner.
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A straddle trader would presumably not trade blind "at the open/close".
presumably that trader would sell the straddle on the breakdown of some
technical level, and try to capture as much premium as possible.
Assuming all traders went long/short at 10 AM seeing the same technical
breakdown formation on their screens and placing trades,
a. Short straddle gets a credit of $532.50 on puts and a credit of $400 on
calls for a total credit of $932.50 This, if traded out MOC for the same
debit of $765 gives the trader a gross profit of $167.50 per contract.
b. Long puts gets a debit of $532.50 and is worth $432.50 at close, even as
price at close was unchanged from TLAB price at entry ($58.0625 and a print
low of 56.9325).
This was my point on the chart, where I anticipated that a Short straddle
would be more profitable than long puts or long calls, all other things
being equal.
Volatility collapsed, price went sideways for the rest of the day.
In the FWIW dept,
a/ short straddles do carry nasty risk, and are not recommended for traders
without deep pockets, intra-day volatility data and a clear understanding of
maximum adverse excursion.
b/ Volatility contraction often occurs on the first couple of days after
expiration. This also lent the straddle an inherent edge.
c/ Margin and account capitalization requirements are completely different
for each of the above specified trades.
Basic intraday charts attached to show above example, implied data etc are
not portable to my PC.
Thanks, Ira, for highlighting the risk element.
Regards,
Gitanshu
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