Trading the Long Straddle
Option trading is all about optimizing the statistical chances of success. A
long-straddle trade makes the most sense if traders think they can make
money on both implied volatility and gamma. Many traders make the
mistake of buying a straddle just before earnings are announced because
they anticipate a big move in the stock. Of course, stock-price action is only
half the story. The option premium can be extraordinarily expensive just
before earnings, because the stock move is priced into the options. This is
buying after the rush and before the crush. Although some traders are
successful specializing in trading earnings, this is a hard way to make
money.
Ideally, the best time to buy volatility is before the move is priced in—
that is, before everyone else does. This is conceptually the same as buying a
stock in anticipation of bullish news. Once news comes out, the stock
rallies, and it is often too late to participate in profits. The goal is to get in at
the beginning of the trend, not the end—the same goal as in trading
volatility.
As in analyzing a stock, fundamental and technical tools exist for
analyzing volatility—namely, news and volatility charts. For fundamentals,
buy the rumor, sell the news applies to the rush and crush of implied
volatility. Previous chapters discussed fundamental events that affect
volatility; be prepared to act fast when volatility-changing situations present
themselves. With charts, the elementary concept of buy low, sell high is
obvious, yet profound. Review Chapter 14 for guidance on reading
volatility charts.
With all trading, getting in is easy. It’s managing the position, deciding
when to hedge and when to get out that is the tricky part. This is especially
true with the long straddle. Straddles are intended to be actively managed.
Instead of waiting for a big linear move to evolve over time, traders can
take profits intermittently through gamma scalping. Furthermore, they hold
the trade only as long as gamma scalping appears to be a promising
opportunity.