Stocks & Commodities V. 31:1 (53): Explore Your Options by Price Headley

Explore Your Options by Price Headley

STRADDLES AND THE SPX

Will the straddle work with index options like SPX? I’d given up on individual stocks and have been trading SPX options exclusively. Except for the price of the premiums, it seems to make little difference in volatility if I buy the SPX options in- or out-of-the-money (OTM), so I buy them OTM for the cheaper premiums. I remember reading about straddles and spreads, and correct me if I’m wrong but the behavior of options on individual stocks seems to depend on whether they are in or out of the money, and I thought that was the key to straddle/ spread strategies. Am I correct in thinking these strategies won’t work for index options? Are there similar strategies that can be employed that work to hedge risk and make money both ways with index options like for SPX?

First, here’s how a straddle works. Say XYZ shares are trading at 50 and you expect the stock to be volatile, up to the 60 area of higher or down to 40 or lower over the next several months. The only issue is you don’t know which way it’s going to move first. The straddle purchase is an option strategy, which can get you on board the start of a big move.

By purchasing the six-month XYZ 50 call and simultaneously buying the six-month XYZ 50 put, we now have a position that can benefit as long as XYZ shares are even more volatile than expected. When you buy the same strike price on both sides, it’s known as a straddle. If the strike prices are different, it’s called a strangle. The key to success in buying straddles is what you pay for the call and put option relative to the volatility, which is implied or expected to occur. There are factors to consider in getting the cheapest straddles, which can offer the greatest leverage in a potentially volatile move: