The Straddle Secret

A straddle is a form of option buying where you buy both a put and a call on the same underlying stock or futures, both with the same strike price and expiration month. Then the underlying can move either up or down to win, and sometimes you can win
on both sides.

I am not usually a great fan of straddles because their price tag is usually pretty high and you could be stuck with an expensive option position. If the underlying stock or futures does not move, you could take a beating.

However, if you can find a cheap straddle with plenty of time, you could find a strategy with a high probability of generating a profit, and that is very rare for a position where you have limited risk. In other words, you cannot lose more than you paid for the positions (the put and call).

For example one of my plays of the week in Ultimate Option Strategies was a straddle on the stock, Terra Networks, where you bought the Dec 7.5 call and 7.5 put.

The combined price of the two options was 1.5. This means that Terra Networks would have to drop to 6 to break even (7.5 – 1.5 = 6) or rise to 9 to break even (7.5 + 1.5 = 9).

To analyze this position, we ran a computer simulation to determine the probability of one of our profit points being hit during the life of the trade. This analysis is only possible through computer simulation, and such simulation can be done on Option
Master® Deluxe software.

Based on that analysis, we found that there was a 80% probability of showing a profit some time during the life of the options.

In addition, I looked at the charts and made sure Terra Networks, an internet stock, had been an extremely volatile stock in
the past. In September of 2001, the stock dropped down to 5, generating a good profit for the position.

Two internet programs that will help you find good straddles are The Power Analyzer and The Option Research Scanner, available at options-inc.com. Nevertheless, once you find what looks like a good straddle, make sure you run a simulation on the
straddle and only enter such trades where you have an 80% or better probability of profit.

Most of the straddles I have recommended over the years have been profitable, probably due to the fact we only selected straddles with over an 80% probability of
profit.

Finding a good straddle is only half the game. Taking profits on such trades is your next challenge. Here apply the rules we discussed previously.

When you have a profit, scale out of positions and set tight trailing stop-losses so profits won’t slip away.

Also, when you take profits on one side of the position, you may wish to sell the other side if there is some option premium left.

For more click here