Straddles and Strangles are delta neutral and speculative trades. They are expensive but can be very profitable if structured correctly with the right timing and considerations.
I have been testing on straddles and strangles. Recently I tested it on a very volatile stock that normally moves a lot during earnings. – FSLR. The results were very interesting!
Considerations:
· Trade were placed one week before earnings where IV was reasonably low.
· Bollinger band was narrow and stock was trading at a narrow range – a low ATR
· It was 1 week before earnings
· When choosing the strangles, I tried to find trades where the delta were balanced i.e. the delta of put should be roughly equal to the delta of call
· I placed 4 kinds of trades
1. A longer term call and a short term put : bullish bias calendar strangle
2. A longer term put and a short term call: bearish bias calendar strangle
3. A short term straddle of 30 days
4. A longer term straddle of 95 days
As seen from the results above, the following observations are made:
· The best ROI is a short term straddle.
· IV increased made both the put and call profitable without movement of the stock. Stock price was around 152 on Oct 28th. When I placed the trades, the stock price on Oct 21st, the stock price was around 152.5.
· Even the stock gapped down, return of the bearish bias diagonal calendar strangle was only marginally higher than the bullish diagonal calendar strangle.
· The cheapest trade was the short term straddle and thus it gives the best ROI. As long as the stock moves, it makes the most money. It also makes most money in absolute value.
This may be contrary to the idea that straddle must be placed a little way out in time to minimize theta decay. The gamma, VEGA and IV effects more than compensate the theta decay. Also, this trade is meant to be a short term trade and thus may not be necessary need longer time. Unless you need more time for the trade to work, it is not necessary to place a longer term straddle.
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Good study.
ReplyDeleteI think if you place the straddle as speculative trade, it is better with short term months. Like you mention, we can get better returns.
But in case we apply the straddle in a stock with good fundamentals, that we know the long-term expectancy is bullish, maybe it would be better a straddle with more months to expiration, so we can adjust the position in case we don't get the return on the earnings date.
Sergio.
Nozal has a good point.
ReplyDeleteThe time frame of your strangle / straddle really depends on the anticipation of the event.
If you think the event will not happen immediately, it is good to stretch the straddle/strangle further out.
In this case, you make less money if it happens shorter than you anticipated but it reduces your risk as you will have more time on your side for adjustments.
How weird. +3 years later and I too am looking at a long straddle on FSLR and stumble across this blog.
ReplyDeleteMy question is whether the ROI was larger for the front month option after the E.R. because the back month option had already expanded a sizeable amount due to vega prior to your purchase and ended up losing more extrinsic value after the E.R. as a result?