Options Strategy III

Now we know how we trade options in the market. So let us learn another strategy .



Straddles and Straddle Strategy :-



Well its a general mis conception that poeple can only make money by predicting whether market will go up or go down in medium term or a stock will go up or go down in near future.

Now what if you know that a court case is pending or a order is pending for a company which could go either ways. You are not in a position to guess what will happen. It can go either ways. But you are sure that either ways the stock will ''Move'' Either it will go up or it will go down whatever be the outcome.



In an ideal world, we would like to be able to clearly predict the direction of a stock. However, in the real world, it's quite difficult. On the other hand, it's relatively easier to predict whether a stock is going to move



So if you know that the stcok price will be volatile in a short term you can make money using this strategy. This is how it works.



To initiate a Straddle, you will buy a Call and Put of a stock with the same expiration date and strike price. For example, let us assume annual report is SAIL is comming and you r not sure that how the results will be but you are sure the stock will not remain flat but will move in either direction.



We would initiate a Straddle for company SAIL by buying a August Rs 120 Call as well as a August Rs120 Put. Now the first thing which will come to your mind is why the hell would you buy both. (You buy a call when u think the price will go up while you would buy a put when the price will go down.) But here you just know that the price will be volatile.





Now Two things can happen when the results for SAIL are out



1) The results are good and the stock moves northwards. In this Case PUToption will be worthless but your CALL option will be IN THE MONEY so the premium of the CALL option will raise and you can now sell the CALL option and make profits.



2) The results are BAD and the stock price dives southwards. In this case you CALL option will be worthless but you will earn profits on your PUT option.





Let us take the same SAIL example



We would initiate a Straddle for company SAIL by buying a August Rs 120 Call as well as a August Rs120 Put Option. Now the premium for the Call option is Rs 0.75 ( it is less as this is OUT OF MONEY option ( the current price of stock is less that the strike price ) ) and the premium for Put option is Rs 3.00 ( as this is IN THE MONEY option ( the current price of stock is less that the strike price)). So your total investment is Rs 3.75 ( 0.75 + 3) for both options.



Now after the results the stock price rises to Rs 122 in two days. Now your call option of Rs 120 will be IN THE MONEY ( why ? try to figure this out yourself and write in the comments if you dont understand ) and your PUT option will be OUT of money. So the premium of the call and out options will change.



Let us put this in a table.


XYZ Day 1 Day 3

Stock Price Rs118 Rs122
Rs120 Call In-The-Money Out Rs2 In Rs7
Rs 120 Call Premium Rs0.75 RS8.00
Rs 120 Put In-The-Money In Rs2 Out Rs7
Rs 120 Put Premium Rs3.00 Rs0.25
Total Option Value Rs3.75 Rs8.25
Profit - Rs3.75 Rs 4.50



You could have just bought a basic Call option and earned a greater profit. But you didn't know which direction the stock price would go. If SAILS report is BAD , the price could have dropped Rs 10 , making your Call worthless and causing you to lose your entire investment. A Straddle strategy is more conservative and will profit whether the stock goes up or down.



if this is such a good strategy why dont everyone makes money out of this strategy ???

Well the downside is if the price dosent move for a long time your both calls will become worthless and you will lose your investment completely!



Also the premium you paid for your investment in SAIL will keep on decreasing as time goes on. The premiums for this months CALL/PUT options will be cheaper than the premiums of next month. So if the price dosen't move the premiums of both the options will become cheaper and will eat away your profit. So the bottom line is this strategy is ONLY useful when there is volatility in the market or that specific stock.