24 lines
1.5 KiB
Plaintext
24 lines
1.5 KiB
Plaintext
from the strike price in either direction, the higher the net value of the
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options.
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Above $70, the call has value. If the underlying is at $74.25 at expiration,
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the put will expire worthless, but the call will be worth 4.25—the price
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initially paid for the straddle. Above this break-even price, the trade is a
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winner, and the higher, the better. Below $70, the put has value. If the
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underlying is at $65.75 at expiration, the call expires, and the put is worth
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4.25. Below this breakeven, the straddle is a winner, and the lower, the
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better.
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Why It Works
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In this basic example, if the underlying is beyond either of the break-even
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points at expiration, the trade is a winner. The key to understanding this is
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the fact that at expiration, the loss on one option is limited—it can only fall
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to zero—but the profit potential on the other can be unlimited.
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In practice, most active traders will not hold a straddle until expiration.
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Even if the trade is not held to term, however, movement is still beneficial
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—in fact, it is more beneficial, because time decay will not have depleted
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all the extrinsic value of the options. Movement benefits the long straddle
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because of positive gamma. But movement is a race against the clock—a
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race against theta. Theta is the cost of trading the long straddle. Only pay it
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for as long as necessary. When the stock’s volatility appears poised to ebb,
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exit the trade.
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Exhibit 15.2 shows the P&(L) of the straddle both at expiration and at the
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time the trade was made. |