Q & A. Buying Straddles

Mark:

I just want to thank you for options advocacy on your blog and your books. I stumbled onto your blog sometime in the summer and over time it caused me to seriously consider using options. The volatile, falling market has made writing calls on my positions practically a no-brainer.

That general strategy has preserved the value of my Roth for the year.

As an option newbie, I am still coming to grips with option values and use. Although I have never seen you advocate what I did, I thought I might relate something I did for its expository value. On the 25th of Nov I bought 1 Dec 7.50  C (Citibank) straddle. This did not go well and taught me the following (I seek correction from you on these points).

1) straddles are quite speculative (and you'd better have a better bet than "this is really volatile")

2) straddles are expensive when the market is volatile

3) the underlying must move tremendously after such a rapid fall for straddles to have much chance to make money

4) low value stocks tend not to make good straddles

5) low value stocks of large firms may be interesting to big players

6) get out as soon as you know you are wrong

I failed to see right away the news that Slim [who is Slim?] had snapped up a significant stake or I would have exited earlier than Dec 08. The experience was more expensive than all your books, but not life (or portfolio) threatening.

While exciting, I think I shall stick to motorcycles and rock climbing for excitement.

While I may never buy a straddle again, I do think the experience says I am not yet ready for any two leg option strategies. Perhaps next year (maybe under different market conditions) I will have written enough calls (or puts) and rolled enough positions to feel more comfortable with spreads.

Jeff F.

***

Jeff,

You are correct.  I never suggested that anyone buy straddles to make a profit from the trade.  I have suggested that straddles or strangles are appropriate for portfolio protection, but that's a separate discussion.

In general, I prefer option writing to option buying.  I believe too much has to go your way to profit, when buying options.  the potential gains are substantial, but IMHO, it's only suitable for traders who have a proven track record of being able to successfully predict market direction.

Regarding your conclusions [for this discussion 'straddles' means straddles or strangles]:

1) 'This has been pretty volatile' is often a warning NOT to buy straddles.  Once the stock has shown high volatility, the option prices have been bid higher.  They may not be too costly to buy, but it's too late to get a bargain.

When you buy any option, you want to see the underlying stock make a significant move.  Thus, DO NOT buy the straddle unless you have a strong reason to believe that price change is coming.  The fact that it recently made a move is not sufficient reason to believe it's going to happen again.

2) True, but all options are 'expensive' when the markets are volatile and can be very cheap when the markets are nonvolatile.

3) Agree.  But please tell me you knew that before you bought the straddle.  To profit when buying a straddle, you must see a big price change or a large increase in implied volatility.

4) High priced stocks make larger moves.  But, if the options are appropriately priced, it should not make any difference.

5) I have no idea why you would draw that conclusion.  I know of no evidence to support it.

6) Always a sound trading principle.

SPREADS

I don't agree with your conclusion regarding spreads (trades with >1 leg).  Spreads are designed to reduce risk and as such, have an appropriate place in any option trader's arsenal.  For example, it's much less risky to sell a put spread rather than a naked put.  Also, buying iron condors is much far less risky than selling a strangle.

200

2 Responses to Q & A. Buying Straddles

  1. rluser 01/03/2009 at 7:15 PM #

    Carlos Slim Helu purchased around 26MM shares and Inbursa purchased 40MM.

  2. Mark Wolfinger 01/03/2009 at 11:12 PM #

    ok. Thanks