The Strangle: A Killer Trade - Part Three
...continued from Part Two
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VEGA
Since the position is long options and long options havepositive vega, this position is sensitive to changes in volatility,although not as much so as the straddle. (The reason being that the OTMoptions have less vega than the ATM options.) So in addition to pricemovement, we are hoping for an increase in volatility.
Well, thatimplies that we would put this position on in a low volatilityenvironment. Isn’t that the same contradiction we had with the straddle? We want a low volatility environment, but large movement inthe stock! Yes and no; at expiration the volatility doesn’t matteranymore.
The stock price will be whatever it is, and that willdetermine the amount of profit or loss for the position. Prior toexpiration, the volatility can have a great impact on the value of the strangle.
THETA
Once again, we’re still dealing with only long options, andlong options have negative theta, so the position is losing value everyday. Making matters worse, the rate of loss is constantly accelerating.So what can we do to mitigate this situation?
We generally don’t buynear term strangles. Like the straddle, a rule of thumb is thatStrangle buys should be 3 months or more to expiration. I said"generally" for a reason.
As you can see, the long strangle can be a very effective tool and canring in some large profits, but more than anything else you needmovement in the stock price. Since the maximum risk is defined, Iconsider this a low risk, low probability trade, but with a highpercentage return when it is profitable.
Experts will continue todebate the advantages and disadvantages of the strangle relative to the straddle. However, most traders will come to feel comfortable with one or theother. For what it’s worth, since I am basically a volatility trader, Itend to do many more straddles than strangles.
But, then again, each oneof you will have to develop your own style. Unfortunately, there’s notextbook answer.
As always, if you have any questions about my articles, havesuggestions for future topics, or want more information about ouroptions mentoring program, feel free to email me at:sfreifeld@tradingacademy.com or call me at: (888) OTA-2580 ext. 2010.
11. Know Thy Options!"
About Stan Freifeld
Stan Freifeld comes to us from the Floor of the American Stock Exchange where he traded options for his own account from 1994-2001. He was a Market Maker for the options on several popular equities including Dupont, Schering Plough, Walgreen's, CBS, U.S. Surgical and Biovail. Stan, a long time MENSA member, is an engaging teacher with an extraordinary background in options trading and risk management. He is helpful and patient by nature and equally at ease with all levels of traders, from complete novices to advanced pros and academics.
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