Options Analyst Brian Overby fields a question from an email from an options trader whose straddle hasn't gone as planned.A Hi Brian,I tried to follow your discussions on one of the taped webinars, but it's not sinking in. Yesterday I theorized ZNGA was going to move big after earnings was announced after the close, so prior to the close I bought a strangle using the Feb18 15 calls and Feb18 14 puts.
The ZNGA trade as described above is a long strangle because the put and the call that were purchased do not have the same strike price.
If the call and put strikes were the same and with the same expiration the trade would be considered a long straddle.A long straddle or strangle is looking for a big move either up or down, the direction doesn't matter since the bought call gives you the right to buy the stock at a strike price and the bought put gives you the right to sell the stock at a strike price.
Since we are buying the options the risk is the net debit paid for the trade plus any commissions.Whenever you are doing a strategy around an event (like earnings), you have to pay attention to a lot of variables.
In this instance those options were trading at a 227% implied volatility (IV) before the earnings was announced. This is a high IV number for any stock option contractsA period - no matterA what market segment it is located in!


This means the options are very expensive relative to normal times without a news event pending. Also it is harder to lose the entire investment mainly because the stock would have to end right on the strike at expiration to achieve the maximum loss on the trade, which is obviously not the case in the strangle.Second, if performing a straddle you do really want the stock to be close to the strike. Also, if it is close to expiration you have to ask yourself "can the stock move more than the price paid for the straddle (in one direction)".
In the case with the strangle, you need even a bigger move because both of the options are out-of-the-money to start with so it has to make a couple percent move in one direction just to get to a strike.Now in this case the implied volatility dropped was over 100% after the earnings was announced, you received a volatility crunch. This type of volatility crunch is common after an earnings report, especially when you have a very short term option. Lessons do not usually come this "cheap" when trading options.Lastly, the straddle videoA mentioned also goes into detail about how the straddle is priced and why, in most cases, the stock will not make the move priced into the straddle.
The market knows how to price the straddle around an event - in other words the price will be accurate based on the underlying and the previous volatility around earnings.Now, if you come back to me and say "if those are the stats, then I will just sell the straddle naked and 7 out of 10 times it will be a winner".


The risk is unlimited when you are short a straddle so realize it just takes one castrophic move and you are creamed!
Options involve risk and are not suitable for all investors.A Click here to review the Characteristics and Risks of Standardized OptionsA brochure before you begin trading options.
Options investors may lose the entire amount of their investment in a relatively short period of time.A Online trading has inherent risks dues to system response and access times that may vary due to market conditions, system performance, and other factors. Multiple-leg options strategies involvingA additional risks and multiple commissionsA and may result in complex tax treatments.



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