Trading Option Straddles
Many factors should be examined to find good candidates for straddles. The Stock Option Straddle Screener analyzes options and identifies straddle candidates. Buying straddles can be expensive and the probability of profit is lower than selling straddles. Nonetheless, long straddles can capture profit on short term price moves, and the potential profit is greater than that of short straddle positions. The potential profit is greater, but the probability of profit is smaller.
Short selling straddles has a higher probability of return, though that return is limited to the proceeds from the sale of the straddle. Long straddles are typically held for shorter periods, since the time decay for holding two simultaneous options can be costly. On the contrary, the short straddle holder hopes to collect the premium lost due to time decay, and will generally have to hold this position to realize a profit.
It is difficult to predict the direction a stock will take. The theory behind buying straddles is that a profit can be made regardless of the direction a stock moves. Widely anticipated news, such as pending earnings or anticipated settlement of litigation, can drive option premiums higher and increase the cost of buying options. The revelation of the news may or may not effect the stock price, but the absence of the event that was expected to effect the stock price will result in a drop in option premium. This can be costly to the option buyer.
Candidates for long straddles are stocks that:
- are expecting a price move, perhaps due to merger rumors, impending earnings, settlement of pending litigation settlement, etc.
- have relatively low premiums, (i.e. have not had their prices driven up by the anticipation of news).
- have liquidity in the option market, avoid options with little or no open interest or volume
Use the Straddle Screener.
The perfect short straddle candidate is a stock that has high short term volatility, but ultimately stays near the current price or the strike price. Short straddle sellers should avoid stocks that have shaky underpinnings or histories of wild price swings. Good candidates for short straddles:
- Have relatively high market caps
- A stable earnings history
- have just experienced an unusual, but explainable, price move
- yield 10% or more selling two months out
- have liquidity in the option market, avoid options with little or no open interest or volume
Use the Straddle Screener.