Narach Investment

OPTIONS TRADING STRATEGIES IN A STABLE MARKET


Volatile market trading strategies are appropriate when the investor believes the market would move but does not have an opinion on the direction of the movement of the market. As long as there is significant movement upwards or downwards, these strategies offer profit opportunities; an investor need not be bullish or bearish. He must simply be of the opinion that the market would be volatile; this market outlook is also referred to as "neutral volatility".

Straddles in a Stable Market outlook: A straddle is the simultaneous purchase or sale of two identical options, one a Call and the other a Put. To "buy a straddle" is to purchase a Call and a Put with the same exercise price and expiration date. To "sell a straddle" is the opposite, where the investor would sell a Call and a Put with the same exercise price and expiration date.

An investor with a view that the market would be stable would write option straddles. A "straddle sale" allows the investor to profit from writing Calls and Puts in a stable market environment.

The investor's profit potential is limited. If the market remains stable, the long out-of-the-money Calls and Puts would let their options expire worthless. The writers of these options would not have to be called to deliver; and would profit from the sum of the premium received.

The investor's potential loss is unlimited. Should the price of the underlying asset rise or fall, the writer of a Call or Put would have to deliver, exposing him to unlimited loss if he has to deliver on the Call and practically unlimited loss if on the Put.

The breakeven points occur when the market price at expiration equals the exercise price plus the premium and minus the premium, respectively. The investor is short two positions and thus, two breakeven points; one for the Call (common exercise price plus premium paid) and one for the Put (common exercise price minus the premium paid).

Strangle in a Stable Market outlook: A strangle is similar to a straddle, expect that the Call and the Put have different exercise prices. Usually, both the Call and the Put are out-of-the-money. To "buy a strangle" is to purchase a Call and a Put with the same expiration date, but different exercise prices. Usually, the Call strike price is higher than the Put strike price. To "sell a strangle" is to write a Call and a Put with the same expiration date, but different exercise prices.

The investor viewing the market as stable would write a strangle; as a "strangle sale" would allow the investor to profit from a stable market.

The investor's profit potential is unlimited. If the market remains stable, investors having out-of-the-money long Put or long Call positions would let them expire worthless.

The investor's loss is unlimited. If the price of the underlying asset rises or falls instead of remaining stable as the investor had anticipated earlier, then he would be required to deliver on the Call or on the Put.

The breakeven points occur when the market price at expiration equals the higher exercise price plus the premium and the lower exercise price minus the premium.

The investor is short two positions and thus, two breakeven points. One for the Call (higher exercise price plus the premium paid) and one for the Put (lower exercise price minus the premium paid).

An investor would chose to sell a strangle rather than a straddle, as the risk would be lower. Although, the seller gives up a substantial amount of the potential profit by selling a strangle rather than a straddle, he also hold less risk. Notice that this strangle requires more of a price move in both directions before it begins to lose money.

Long Butterfly Call spread strategy: The Long Butterfly Call spread is a combination of a bull spread and a bear spread, utilizing Calls and three different exercise prices.

A Long Butterfly Call spread involves; buying a Call with a low exercise price, writing two Calls with a mid-range exercise price and buying a Call with a high exercise price.

For instance, to put on a Sept 40-45-50 Long Butterfly the investor would buy the 40 strike and the 50 strike and sell two 45 strikes. This spread is putting on one each of the outside strikes and selling two of the inside strikes. To put on a Short Butterfly spread, the investor would do just the opposite.

The investor's profit potential is limited. Maximum profit is achieved when the market price of the underlying asset equals the mid-range price (if the exercise prices were to be symmetrical).

The investor's potential loss is limited. The maximum loss is limited to the net premium paid and would be realized when the market price of the underlying asset is higher than the higher exercise price or lower than the lower exercise price.

The breakeven points occur when the market price of the underlying asset at expiration equals the higher exercise price minus the premium and the lower exercise price plus the premium. Conversely, the strategy would be profitable when the market price of the underlying is between the lower exercise price plus the net premium and the higher exercise price minus the net premium.

We would strongly recommend that the investor first study these investment instruments along with the above listed strategies; conduct dry runs with pen and paper; understand the nuances of the dynamics of the underlying security and the connectivity between the various risks that he or she would be taking on during the pendency of a futures or options position held by him. The strategies provided here are academic in nature; and the information should be used by investors who are aware of the risks inherent in investing and trading in options in the equity markets amongst other financial instruments. Narach Investment accepts no liability whatsoever for any loss arising from the use of this website and its contents.