World Economy

Jun 26, 2006

Stable Market Strategies
Straddles in a Stable Market Outlook
Volatile market trading strategies are appropriate when the trader believes the market will move but does not have an opinion on the direction of movement of the market. As long as there is significant movement upwards or downwards, these strategies offer profit opportunities. A trader need not be bullish or bearish. He must simply be of the opinion that the market is volatile. This market outlook is also referred to as "neutral volatility."
A straddle is the simultaneous purchase (or sale) of two identical options, one a call and the other a put.
To "buy a straddle" is to purchase a call and a put with the same exercise price and expiration date.
To "sell a straddle" is the opposite: the trader sells a call and a put with the same exercise price and expiration date.
A trader, viewing a market as stable, should: write option straddles. A "straddle sale" allows the trader to profit from writing calls and puts in a stable market environment.
The investor's profit potential is limited. If the market remains stable, traders long out-of-the-money calls or puts will let their options expire worthless. Writers of these options will not have be called to deliver and will profit from the sum of the premiums received.
The investor's potential loss is unlimited. Should the price of the underlying rise or fall, the writer of a call or put would have to deliver, exposing himself to unlimited loss if he has to deliver on the call and practically unlimited loss if on the put.
The breakeven points occur when the market price at expiration equals the exercise priceplus the premium and minus the premium. The trader is short two positions and thus, two breakeven points; One for the call (common exercise price plus the premiums paid), and one for the put (common exercise price minus the premiums paid).
Strangles in a Stable Market Outlook
A strangle is similar to a straddle, except that the call and the put have different exercise prices. Usually, both the call and the put are out-of-the-money.
To "buy a strangle" is to purchase a call and a put with the same expiration date, but different exercise prices. Usually the call strike price is higher than the put strike price.
To "sell a strangle" is to write a call and a put with the same expiration date, but different exercise prices.
A trader, viewing a market as stable, should: write strangles. A "strangle sale" allows the trader to profit from a stable market.
The investor's profit potential is: unlimited. If the market remains stable, investors having out-of-the-money long put or long call positions will let their options expire worthless.
The investor's potential loss is: unlimited. If the price of the underlying interest rises or falls instead of remaining stable as the trader anticipated, he will have to deliver on the call or the put.
The breakeven points occur when market price at expiration equals...the high exercise price plus the premium and the low exercise price minus the premium. The trader is short two positions and thus, two breakeven points. One for the call (high exercise price plus the premiums paid), and one for the put (low exercise price minus the premiums paid).
Why would a trader choose to sell a strangle rather than a straddle?
The risk is lower with a strangle. Although the seller gives up a substantial amount of potential profit by selling a strangle rather than a straddle, he also holds less risk. Notice that the strangle requires more of a price move in both directions before it begins to lose money.
Long Butterfly Call Spread Strategy The long butterfly call spread is a combination of a bull spread and a bear spread, utilizing calls and three different exercise prices.
A long butterfly call spread involves:
Buying a call with a low exercise price,
Writing two calls with a mid-range exercise price,
Buying a call with a high exercise price.
To put on the September 40-45-50 long butterfly, you: buy the 40 and 50 strike and sell two 45 strikes. This spread is put on by purchasing one each of the outside strikes and selling two of the inside strike. To put on a short butterfly, you do just the opposite.
The investor's profit potential is limited. Maximum profit is attained when the market price of the underlying interest equals the mid-range exercise price (if the exercise prices are symmetrical).
The investor's potential loss is: limited. The maximum loss is limited to the net premium paid and is realized when the market price of the underlying asset is higher than the high exercise price or lower than the low exercise price.
The breakeven points occur when the market price at expiration equals ... the high exercise price minus the premium and the low exercise price plus the premium. The strategy is profitable when the market price is between the low exercise price plus the net premium and the high exercise price minus the net premium.

by erectusplus at 9:24 AM |