When to use: If market is within or near (A-B) range and has been stagnant. If market explodes either way, you make money; if market continues to stagnate, you lose less than with a long straddle. Also useful if implied volatility is expected to increase.
Profit characteristics: Profit open-ended in either direction. Break-even levels are at A – cost of spread and B + cost of spread. However, spread is usually not held to expiration.
Loss characteristics: Loss limited. Loss is equal to net cost of position. Maximum loss occurs if, at expiration, market is between A and B.
Decay characteristics: Decay accelerates as options approach expiration but not as rapidly as with long straddle. To avoid largest part of decay, the position is normally liquidated prior to expiration.
Long put A, long call B
(Generally done to initial delta neutrality)
This trader looks at the low implied volatility and feels that options are relatively cheap. The thinking here is that this market will have a very big move. However, the trader is not sure which way it will be, so he decides to buy both a call and a put. The trader saves on premiums by buying both options out-of the-money. However, the trader must get an even larger move than a long straddle to make this strategy profitable by expiration.
Underlying Futures Contract: December Euro FX
Futures Price Level: 1.0100
Days to Futures Expiration: 65
Days to Option Expiration: 55
Option Implied Volatility: 11.3%
|Long 1 Dec 1.0200 Call||– 0.0500 ($ 625.00)|
|Long 1 Dec 1.0000 Put||– 0.0048 ($ 600.00)|
|– 0.0098 ($1225.00)|
Breakeven: Downside: 0.5002 (1.0000 strike – 0.0098 debit). Upside: 1.0298 (1.0200 strike + 0.0098 debit).
Loss Risk: Losses bottom at 0.0098 with a maximum loss between 1.0200 and 1.0000 strikes.
Potential Gain: Unlimited; gains begin below .9902 and increase as futures fall. Also, gains increase as futures rise past 1.0298.
Things to Watch:
This is primarily a volatility play. A trader enters into this position with no clear idea of market direction but a forecast of greater movement in the underlying futures.
Additional Futures & Options Strategies
- How to Use This Guide
- Long Futures
- Long Synthetic Futures
- Short Synthetic Futures
- Long Risk Reversal
- Short Risk Reversal
- Long Call
- Short Call
- Long Put
- Short Put
- Bull Spread
- Bear Spread
- Long Butterfly
- Short Butterfly
- Long Iron Butterfly
- Short Iron Butterfly
- Long Straddle
- Short Straddle
- Short Strangle
- Ratio Call Spread
- Ratio Put Spread
- Ratio Call Backspread
- Ratio Put Backspread
- Box or Conversion
Contents Courtesy of CME Group.