Rivercity,
Welcome to Part 2 where I will wrap up my earlier post. As I had mentioned, the Option Strategy Scanner does not always get its due when we speak of the free tools available at TradeKing. To launch this tool, please go to Tools > Option Strategy Scanner. (fyi, this will launch in a separate window; adjust your pop-up blocker accordingly) Let's recap briefly:
A straddle is when you buy a call and a put in the same month, with the same strike, at the same time.
Strategy:
Long Straddle
Long leg 1
Bought QQQ Feb 50 C @ 3.13
Long leg 2
Bought QQQ Feb 50 P @ 2.79
Entry
3.13 + 2.79 = 5.92 Debit
Max loss
Limited to debit = 5.92
Max gain*
Theoretically unlimited
Lower breakeven*
44.08
Upper breakeven*
55.92
*based on Feb. expiration; I.V. ~ 30%
Earlier we discussed the importance of relative implied volatility. Allow me to explain further. As shown in the volatility chart, we can see that 30 is quite high for the QQQQ. If we compare that to RIMM the story is quite different. RIMM's I.V. ranges from a low of 26 to a high of 88. (Go to Quotes+Research > Volatility Charts) In the case of the Qs, 30 vol is high, but for RIMM the absolute number of 30 is quite low. This is why we need to look at vol in the context of what is "typical" or relative for that symbol as compared to knowing the absolute volatility.
Click here for a larger image.
The Options Strategy Scanner may help us find stocks in the range desired depending on the strategy chosen. See the image below for the parameters used. When you have a moment, please check out these documents to really utilize the full strength of this tool. http://www.ivolatility.com/doc/RT_Options_Scanner.pdf
http://www.ivolatility.com/doc/RT_Spread_Scanner.pdf
Click here for a larger image.
As with any scanner, the parameters shown are not to be used like a recipe for baking a cake. Bakers become confident in a recipe after testing it many times, but successful trades are not guaranteed. Of course, if I am the one baking, the result may be a shot in the dark! As a guideline, I don't get caught up in the numbers that this scan produces. It is merely a starting point, providing symbols to examine further.
Here's an Options Guy tip from the Options Playbook: Many investors who use the long straddle will look for major news events that may cause the underlying to make an abnormally large move. For example, they'll consider running this play prior to an earnings announcement that might send a stock in either direction. You may find it useful to combine this tool with his comments. These suggestions are offered as a way to begin, but each trader will assume responsibility for the choices made when using these items.
For the chart on QQQQ, please go to Quotes+Research > Charts. What are the chances of this stock breaking outside of the dotted blue lines?
Click here for a larger image.
For that, we can go to the Probability Calculator.
See the image (Tools > Probability Calculator) to see how I tweaked a few things. The break even points of 44.08 and 55.92 are within one standard deviation. Rivercity, that is (or was) good for you, as it is can be common for a stock to make a one standard deviation move in a 3 month period. As time passes, this becomes more and more difficult. The Probability Calculator gives your trade roughly a 40% chance of hitting one of the break even points.
Click here for a larger image.
Whether or not a 40% probability of success is good depends on you and your goals for the trade. Some people trade straddles as lottery tickets. They buy them to hit big. If they fail, the usually expire worthless. Others are in for a time, but decide that some profit or minimal loss is better than an all or nothing approach. These are things we must consider before entering this position.
The higher the implied volatility, the greater the propensity for the stock to move. This should mean your chances should be better for the straddle to be profitable. The catch is that higher volatility means higher premiums. Higher premiums mean wider break even points, and therefore added difficulty in making money in this situation, especially as we move into the last month.
I reread your note, "I'd have done better just to hang on to the whole position, and sell at the end of the day." First and foremost, as a trader you cannot second guess yourself. Indecision and paralysis by analysis is the silent killer for us. We all make the best judgment we can with the information we have at the time. Obviously if you knew that the Qs were going to sell off another buck by the end of the day, you would have stayed in the trade longer. Good job in making a decision.
As for legging out...here is something to consider. Buying a longer term straddle infers that both legs will be exited together because it is more of a volatility play. See Brian's post for more on this: http://community.tradeking.com/members/optionsguy/blogs/2100-understanding-vega-i
I know it is tempting to leg out (exit each separately) to either reduce a loss on the losing leg, or to realize a gain on the winning leg. Keep in mind, the trade is designed to make money on one side. Meddling with it to maximize the result may work against you.
If you do choose to leg out, you may only wish to do so if one leg has profited more than enough to cover the cost of the premium for both the call and the put. If you can pocket a gain only by selling both sides, then that may be the best choice, as you eliminate your risk and lock in a profit. A gain, small or otherwise, beats a sharp stick in the eye any day.
If the straddle is played around an event, and the expected move in volatility or the underlying does not materialize, it may be best to take the loss and move on. You may miss a residual move, but the chances of this happening is now lower, since the cat (e.g. earnings) is out of the bag.
Low volatility is not suited for all option strategies. Check out a recent post of mine on covered calls: http://community.tradeking.com/members/casey/trade_notes/3594-sold-to-open-4-contracts-of-hqf-ac-at-0-85
Rivercity, I would love to hear your take on these comments. Again, thanks for sharing your notes with the Community. They are invaluable to someone just starting out.
This comment and any market data included here were prepared on 1/29/08.
--Nicole Wachs
TradeKing Staff
P.S. If you enjoyed reading this post, check out the brand new All-Star Trades blog. Maybe your trade will be featured next!
Options involve risk and are not suitable for all investors.
Please read Characteristics and Risks of Standardized Options.
While implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or probability of reaching a specific price point there is no guarantee that this forecast will be correct.