Often novice stock market traders consider online trading in derivatives a risky preposition, well that’s not completely true and in our all new derivatives series we will take you through the world of exciting futures and options strategies to help you better understand that how with the help of futures and options we can look for better rewards while taking calculated risks. We will take two popular strategies based on their individual merit and stock market conditions, at the same time draw a comparison between them. Let’s start first with derivatives strategies that are meant to benefit from volatile markets.
Most commonly used options strategy that comes handy in Volatile conditions are commonly known as “long Straddle” and “Long Strangle”.
What is straddle & strangle option in online trading & how does it works
Understanding the “Long Straddle”
Straddle is an option strategy that is formed in order to take advantage of high volatility in the stock markets, irrespective of the direction. There are several occasions like earnings outcome of a stock, election results, central bank meeting, policy announcements etc. where one can sense of high volatility ahead but is unsure about the direction of movement. Long Straddle is one of the simplest and most commonly used options strategies to take advantage from such kind of environments. Long Straddle means simultaneously buying at the money call and put option of the same strike price with the same expiry. The strategy is a net debit transaction where initially the stock trader has to pay the premium of buying both the call and put option, however the risk remains limited to the amount of premium paid in buying the options, while at the same time reward remains uncapped to any extent which makes this strategy so popular amidst traders.
Understanding the “Long Strangle”
A long strangle is very similar to a long straddle strategy in the manner that both bet upon the volatility in the underlying asset , the basic difference however remains that one has to buy out of the money call and put option rather than at the money options. By buying out of the money options this strategy becomes cheaper than the straddle as the breakeven range also become smaller. At times when the cost of out of money option remains relatively cheaper than at the money option this strategy can make good profits. Let’s compare both strategies on their individual merits
Let us understand the long Straddle and long Strangle with the help of an example.
Things to keep in mind while online trading of Long Straddle & Long Strangle
- Both strategies are recommended only ahead of big events where high volatility is expected. In sideways market it will not be profitable as the time value will decrease as the expiry approaches.
- Both should be done when there is sufficient time for expiry and the strategy should be exited early in case the expected movement does not happen, given the fact that time decay is negative for the strategy and reduces the premiums of options as expiry approaches.
- One should always consider the cost of premium that is being paid upfront with the expected movement being betted based on the average trading range of the stock or instrument.
- Generally at the time of exit one should book the printable leg initially and can wait for some reverse action that might provide some value on the other leg as well.
Also Read : Long Call Butterfly and Long Put Butterfly
Online trading of Long straddle and Long Strangle are effective methods to make profits under volatile stock markets; however the high cost attached with this strategy, due to buying at the money options sometimes makes them a bit expensive and less profitable. There are other strategies that address to this issue which we will be discussing in our next articles.