Is buying a straddle a good strategy when expecting a large stock move?
It’s definitely a strategy that’s available, but would it be a good strategy? That depends.
It’s called a straddle because you would buy both the call option and the put option at the same strike price with the same expiration date.
If you are expecting a large move in either direction, then yes, it could be a viable strategy. But you have to understand, the market-makers who provide the bid & ask prices have lots of information at their disposal, so if a large move is expected in the stock, they will price the options accordingly, as to not cause much of a payoff for you, even if you’re right about the large move.
In essence, you would need to have more knowledge than the market to play that strategy profitably.
For instance, let’s say a stock is at $100 per share and you’re expecting at least a $20 move in either direction in the next few days.
You look to buy the $100 straddle, meaning you would buy both the $100 strike call option and the $100 strike put option. And let’s say each one of those options cost $10 each, giving you a total cost of $20 for the whole straddle.
Now, a few days later, the stock actually pops up to $120 per share, and you’re thinking, I must have made a killing. In actuality, the straddle is still trading for $20 ($20 for the call option and $0 for the put option).
At this point, you’re actually just breaking even, even though the stock made a large move of $20 per share.
The market was anticipating this event as well, and priced the options accordingly.
I’m not saying this exact scenario will occur, but the market-makers are pretty darn good about pricing options properly.
Now, if the stock continues to move higher, to $130 per share let’s say, then yes, you will now be profitable and have a $10 gain. But who’s to say the stock will keep going?
If you think you have some kind of information that the market hasn’t heard of yet (hopefully not inside information), then by all means, this could be a great “surprise” strategy. But more times than not, this type of buying strategy fails to produce any significant gains.
That’s why we stick to option selling at The Smart Option Seller. We know how to play the odds.
Read our free report - Put-Selling Basics - to get a taste of what we do.
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