Straddles and Strangles

Dance With Volatility [Morning Reckoning] October 03, 2024 [WEBSITE]( | [UNSUBSCRIBE]( Straddles and Strangles Asti, Northern Italy October 03, 2024 [Sean Ring] SEAN RING Good morning Reader, In times of uncertainty or market turbulence, investors often look for ways to profit from volatility, rather than trying to predict the direction a stock will move. For traders, the concept of volatility itself becomes the most attractive asset to exploit. Two popular strategies for capitalizing on price swings are long and short straddles and long and short strangles. These strategies are designed to profit from volatility, whether the stock price moves up or down. This offers a unique, if expensive, advantage in uncertain markets. In this piece, we’ll examine the mechanics of these volatility trades — long and short straddles and long and short strangles — detailing how they work, when to use them, and their associated risks. Understanding Volatility in the Options Market Before we delve into the specifics, let’s set the stage with a quick primer on volatility. Volatility is the heartbeat of the market, measuring how much a stock price is expected to fluctuate over a given period. Implied volatility, derived from the prices of options, reflects market expectations about future volatility. When volatility is low, stock prices tend to move in narrower ranges. When volatility is high, price swings tend to be larger. Options traders may take advantage of either scenario using strategies that exploit significant movements (or lack thereof) in the underlying asset’s price. [URGENT: Unclaimed Giveaway Offer]( We have an item of considerable value on hold for you in our warehouse. Valued at nearly $300, this [special item]( is an opportunity you wanted to miss. [Click here to see how to claim yours now.]( [LEARN MORE]( The Basics of Straddles and Strangles Both straddles and strangles are types of non-directional options strategies. The goal here is not to predict whether a stock’s price will go up or down, but simply that it will move—hopefully, significantly. Let’s simplify them. What’s a Straddle? A straddle involves purchasing or selling both a call option and a put option with the same strike price and expiration date on the same underlying asset. - Long Straddle: The trader buys both a call and a put option at the same strike price. This strategy profits if the stock moves significantly in either direction, rising sharply or falling significantly. This is known as “buying volatility.” - Short Straddle: The trader sells both a call and a put option at the same strike price. This strategy profits when the stock price stays relatively stable, as the trader collects the premium from both options. This is known as “selling volatility.” What is a Strangle? A strangle is similar to a straddle but with one key difference: the trader buys or sells a call and a put option with different strike prices. The call option is typically purchased at a higher strike price than the current stock price, while the put option is purchased at a lower strike price. - Long Strangle: The trader buys both a call and a put with different strike prices, betting that the stock will make a significant move in either direction. This strategy is typically cheaper than a long straddle because the options are further out of the money. Like a long straddle, this, too, is buying volatility. - Short Strangle: The trader sells both a call and a put with different strike prices, hoping the stock will not move much, and the options will expire worthless. The trader profits by pocketing the premiums from selling both options. Like a short straddle, this is also selling volatility. Now that we’ve outlined the basic structure of straddles and strangles, let’s explore the scenarios in which each strategy should be employed. The Long Straddle: Betting on Big Movements How it Works: A long straddle involves purchasing both a call and a put option at the same strike price. For example, if NVDA is trading at $100, you might buy a call option with a strike price of $100 and a put option with the same strike. Your goal is to profit from a sharp move in either direction. If NVDA skyrockets to $130, your call option will rise significantly, potentially leading to substantial profits. Conversely, if NVDA plunges to $70, your put option will be highly profitable. But remember, you paid premiums on both the call and the put, so this strategy isn’t cheap. This strategy works well when you expect increased volatility but don’t want to bet on the direction of the price movement. When to Use It: Long straddles are ideal when you expect a stock to experience significant volatility but aren’t sure whether the stock price will rise or fall. This could be ahead of a major earnings report, the announcement of new regulations, or significant geopolitical events—any situation where a company or the broader market may see increased price movement. Being aware of these events gives you a strategic advantage. Risks: The main risk with a long straddle is if the stock price doesn’t move much. Both the call and put option could lose value, leading to a loss equal to the combined cost (premium) of buying both options. For the strategy to be profitable, the stock price must move enough to cover the premiums paid for both options. The Short Straddle: Profiting from Stability How it Works: A short straddle is the opposite of a long straddle. In this case, you sell both a call and a put option at the same strike price. You’re betting that the stock won’t move significantly, allowing both options to expire worthless. You keep the premium collected from selling the options. For instance, if you sell a $100 call and a $100 put on NVDA, and NVDA stays close to $100, you’ll collect — and keep — both premiums as profit. When to Use It: This strategy is ideal in low-volatility environments or when you believe the market is overestimating how much a stock will move. You’re essentially taking advantage of the market’s expectation of volatility and profiting from stability. In the world of fixed income, for years, traders sold straddles on the Fed Funds rate because they knew the Fed wouldn’t budge. They made millions off it. Risks: The risk with short straddles is unlimited. If the stock price moves dramatically — either up or down — your losses could be substantial. If the stock skyrockets, the call option you sold will lose value; if it tanks, the put option will lose value. Given this risk, short straddles are typically employed by advanced traders who have strong convictions about market stability. This strategy has a negative gamma. In plain English, you lose more than your model anticipates. This type of trade caused Nick Leeson to blow up Barings Bank in 1995. Beware. And be wary. The Long Strangle: A Cheaper Bet on Volatility How it Works: A long strangle is a variation of the long straddle but with a twist: you buy a call and a put with different strike prices. For example, with NVDA trading at $100, you might purchase a $110 call and a $90 put. You’re still betting on volatility, but this strategy tends to be cheaper because both options are out of the money. Profit potential arises if the stock significantly moves above $110 or below $90. The upside is unlimited, and the cost of entering the position is lower than a long straddle. When to Use It: A long strangle is a good strategy when you expect a big move but want to reduce your initial outlay compared to a long straddle. It’s a more budget-friendly way to play volatility, but it requires a larger move in the underlying stock to become profitable since both options start out of the money. Risks: Similar to the long straddle, the risk is that the stock doesn’t move significantly, and both options expire worthless. Because the options are out of the money, the stock needs to move more than it would in a straddle for the position to become profitable. The Short Strangle: Limited Volatility, Limited Profits How it Works: A short strangle involves selling a call and a put with different strike prices. For instance, you might sell a $110 call and a $90 put on NVDA if it’s trading at $100. As with the short straddle, you’re betting that the stock won’t move significantly, and you collect the premiums from selling both options. Because the options are further from the current stock price, this strategy has a wider profit range than a short straddle, though the premium collected is smaller. When to Use It: A short strangle is ideal in scenarios where you expect limited volatility but want a margin of safety. You’re still betting on stability but with less risk than a short straddle. It’s a common choice for traders in range-bound markets or when implied volatility is unusually high. Risks: Like the short straddle, a short strangle carries significant risk. If the stock moves significantly, you’ll incur losses on either the call or the put, depending on which direction it moves. However, because the strike prices are further apart, the potential for significant losses is reduced compared to a short straddle. Wrap Up [It’s incumbent upon me to tell you that I never sell options]( unless I’m closing a long options position. But I also want to show you the markets, and these trades play an important part. Many traders sell options profitably… until they don’t. However, volatility trading provides a versatile approach to navigating uncertain markets through strategies like long and short straddles and strangles. Whether you're looking to profit from sharp price movements or betting on calm, range-bound trading, these strategies offer a way to trade on volatility without needing to predict the direction of price changes. But they also come with unique risks. Long strategies require enough movement to cover the cost of premiums, while short strategies expose you to potentially unlimited losses. Knowing when to use each strategy — and carefully managing your risk — helps turn uncertainty into opportunity. As always, these options strategies require a solid understanding of the risks involved and a well-timed approach. Stay sharp and watch the markets carefully — because in volatility, the only certainty is uncertainty. Good hunting! [Sean Ring] Sean Ring Contributing Editor, The Morning Reckoning feedback@dailyreckoning.com X (formerly Twitter): [@seaniechaos]( [INCOMING: 50% Election Crash, No Matter Who Wins]( [Click here to learn more]( Former White House Advisor Jim Rickards has uncovered a Dem plot that could crash the market 50% come election day. This information is for American Patriots only. [PREPARE NOW]( [LEARN MORE]( In Case You Missed It… Raging Bulls Take Over the World Greg Guenthner, Editor [Greg Guenthner] GREG GUENTHNER Good Morning Reader, The major averages are barreling into the fourth quarter perched near all-time highs. The S&P 500 is now up more than 20% year-to-date, and more than 60% off its bear market lows posted in late 2022. US stocks are strong — no doubt about that! I spend most of my time analyzing and trading US stocks. It’s called home bias – the tendency for investors to favor domestic stocks over foreign investments. Here in the US, home bias has been incredibly effective. American names have been outperformers for some time now… But I have to warn you… The bulls are beginning to run wild across the world. If you’re like me and mostly focus on US names, it’s time to broaden your horizons to profit from a growing global bull. Today, I will show you what countries are exploding higher — and how you can take advantage of these unprecedented rallies. But first, you have to toss out any preconceived notions you might have about these former laggards. Once you have a few years of trading under your belt, you probably curate your own list of “untouchable stocks” tucked away on a scrap of paper somewhere near your computer. For me, these are a list of individual names that always find a way to work against men or stocks that tend to produce wild, whipsaw moves that make timing entries and exits next to impossible. I’ll also add entire sectors (or even countries) to my untradeable bucket. The trend usually dictates these entrants. As a general rule, I don’t want to own names that are stuck in long-term downtrends — especially ones that have failed to demonstrate any desire to build a constructive base or challenge resistance levels. As you can probably guess, China has been on my untouchable list for a long, long time. Frankly, most of these stocks weren’t worth trading. Every time it looked like some of the more popular Chinese names would go on a run, bad news would hit and the entire group would reverse and trend lower again. Sure, we’ve seen some decent rallies here and there. Most recently, some of the more popular China names enjoyed extended rallies during the 2020 Covid trading bubble. But the pandemic hangover was especially rough on China. The iShares China Large-Cap ETF (FXI) peaked in early 2021, almost a full year before the US averages. And the bear market hit China's large-caps especially hard. They logged a peak-to-trough drop of approximately 60% before bottoming out in late 2022 in a move that deeply undercut the Covid crash lows of 2020. In fact, this group was slumping to prices not seen since 2009. I don’t know about you, but I don’t get too excited about stocks that are crashing to 13-year lows. Until they stop crashing… The Bounce Heard Around the World Up until a couple of weeks ago, Chinese stocks were a total dumpster fire. Dead money walking. But that’s all changing as we witness a dramatic upside reversal. The Shanghai Composite didn’t just stop going down — it kicked off the new trading week by posting its biggest one-day rally since 2008. It has now ripped more than 20% over the past 5 days. What triggered this insane move? For starters, the Chinese government came out of nowhere last week, announcing massive easing plans and stimulus in what the Wall Street Journal is calling a “torrent of policy moves aimed at supporting the struggling economy and stock market.” The result: China shares exploding higher off multi-year lows as investors flock back into these forgotten stocks. There are even rumors circulating about investors pouring back into stocks as Chinese brokers struggle to meet the demand of new investors opening accounts. I think there’s still a lot of money that could be deployed in China in Q4 — just look at that broken downtrend. The Shanghai hasn’t booked monthly returns like this since the heart of the 2006-2007 and 2014-2015 rallies. This huge rally is just getting started… and it’s not the only country finding its footing right now. The World Wakes Up China’s getting more than its fair share of attention as these forgotten stocks spring back to life. But it’s not the only country experiencing some positive momentum right now. Emerging markets across the globe are heating up, from Asia to Latin America. Here’s a brief list of the best performers: - Egypt and India’s Nifty 50 each logged new all-time highs last week. - Indonesia posted new highs in mid-September. - Brazil notched new all-time highs in August. - Peru just posted its highest weekly close in history. Developed markets are also enjoying more than their fair share of bullish action. Just look at what’s unfolding in Europe: - The German DAX, Swedish OMX 30, and Irish Stock Exchanges all closed at all-time highs. - Hungary, Estonia and Czech stocks are strong. - With so many individual country indexes hitting new highs, the Euro STOXX 600 is also posting new all-time highs. - Italy is challenging its year-to-date peak. - Spain and Greece have a little more work to do, but they’re both within striking distance of new 10-year highs. - Plus, the European Bank Index added 4.00% to its rally last month. How bad can it be when European Banks are catching a bid? It’s nearly impossible to be bearish with so many markets across the world firming up and running to new highs. It’s time to remove your US bias to take advantage of a bull market that is quickly spreading across the globe. I’ve already removed Chinese stocks from my untouchable list. I expect many of these names to remain in play through the fourth quarter. In fact, this could be where you find the biggest momentum moves heading into 2025. Best, [Greg Guenthner] Greg Guenthner Contributing Editor, Morning Reckoning feedback@dailyreckoning.com Thank you for reading The Morning Reckoning! We greatly value your questions and comments. Please send all feedback to [feedback@dailyreckoning.com.](mailto:dr@dailyreckoning.com) [Sean Ring] [Sean Ring, CAIA, FRM and CMT]( is a former banker and financial educator and is the editor of the Rude Awakening. Sean has trained interns and graduates from Goldman Sachs, Morgan Stanley, Citi, Bank of America, Standard Chartered Bank, DBS (Singapore), the Abu Dhabi Investment Authority (ADIA), Bank Indonesia (the central bank), HSBC, Barclays, RBS, and BlackRock. He knows the global economy is being corrupted by forces that most people can't understand and has used his unique and worldly experiences to help people navigate the markets. 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