Q & A. Weekly’s Put Spreads and Straddles

Two ideas from a reader.

Mark,
I think vertical spreads (bullish put spreads )would be the way to go. Especially on the Weeklys. Find a stock or etf that barley moves, and make sure u sell the profitable side before expiration, and let the loosing side expire… It’s a no brainer for streaming income…

OR buy straddles or strangles during earning season, and only buy highly volatile stocks…same as above.. Close out the winning side and let the other expire worthless.. Better chance using these strategies to make $ than many other strategies .

Bill

Hi Bill,

I agree that vertical credit spreads represent an excellent opportunity to make money with limited risk — as long as position size is appropriate.

However, reality is not quite as simple as you describe it. For one thing, it is difficult for the inexperienced trader to earn income as a straddle buyer.

Vertical spreads

  • Weeklys options tend to be low priced, and that makes the available premium small.
  • If you use stocks or ETFs that “barely move” then the option premium will reflect the non-volatility of these stocks. Translation: very small premium with very little profit potential. We each have out own idea of how much credit to accept for a 5- or 10-point spread, but I do not like the idea of accepting only $0.05 or $0.10, even though the odds of having a winning trade are high.
  • “Close out the winning side” and allow the other to expire worthless is not viable, in my opinion.
    1. When selling credit spreads, the usual practice is to sell OTM options — with the hope that all options will expire worthless. Thus, there is seldom a “winning side.” And when there is, the other side will not be too far out of the money and carrying it naked short is far too risky.
    2. Selling one side leaves the trader with a naked short position. Although a reasonable strategy for the experienced trader, I strongly discourage newer traders from owning naked short positions. When the option is a call, most brokers will not allow their customers to own such positions because (in theory) the potential loss is unlimited.
    3. I like the idea of no-brainer strategies as much as anyone, but in the trading world, these strategies rarely occur and most fall under the umbrella of “arbitrage.” For me, this plan has a small possibility of causing a giant loss (after selling your long option), and that takes it out of the no-brainer category.
  • When trading Weeklys, instead of adopting your suggested approach, I’d prefer selling the options naked in the first place, rather than buy the spread and then sell the long option 2-3 days later. I’m not recommending this plan, but if position size is small, it should work better – especially when the premium for a spread is so little.

Straddles

Buying straddles in earnings season is a high-risk play. It can work, and one advisor whom I know has done very nicely with this strategy. But it is mandatory to do your homework. The timing of the purchase (never at the close of trading when earnings will be announced prior to the next day’s opening) matters. Some stocks lend themselves to the straddle play better than others. Again do your homework.

It is very acceptable to sell the winning side, but in my opinion, that sale should be made sometime near the opening of trading. NEVER enter a market order; and especially not at the opening. Always use limit orders. You bought an option at high volatility and you cannot afford to hold and allow residual time value to decay. Do not turn this into an investment.

Yes, you can allow the non-winning portion of the strangle to expire worthless, but I believe that it is far better to sell it at the same time that you sell the winning portion of the trade. Of course, I would not sell for as little as $0.05 or $0.10 (because miracles do happen), but $0.50 is real money when trading straddles and you cannot simply allow that cash to get away.

One more point: When the earnings news is right on target, your straddle will lose a lot of value. Accept that and dump the position before IV collapses even more than it did at the opening of trading.

One Response to Q & A. Weekly’s Put Spreads and Straddles

  1. Bill 08/21/2014 at 4:50 AM #

    Hi Mark,
    Thanks for the prompt reply. You seem to be a very knowledgable individual for option strategies I too have some knowledge in options, however not as thorough as yourself. However, I stated that the vertical spreads was a good source for streaming income not straddles or strangles. but thatks for your input.. BTW, you have a great blog/website.. keep it up.

    Bill
    Orange, CT

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