Stocks & Commodities V. 26:3 (62): Explore Your Options by Tom Gentile

Explore Your Options by Tom Gentile

SIZING UP A STRADDLE BUY

I was looking at a particular stock for a possible straddle. The company is expected to release earnings in 10 days. Suppose I intend to purchase options that have 50 days left until expiration. According to my calculations, the straddle can be initiated for a debit of $400 ($2.00 for the put and $2.00 for the call), which is also my maximum risk. If I intend to hold this trade for only 10 days, would 5% of my account size be a prudent amount to risk? For example, if my account size is $10,000, I can only do one contract straddle if I was holding the trade close to expiry, but I can do more if I was only holding it for only 10 days. Am I right? The risk is less if my time frame is 10 days instead of 50?

Your question brings up some important factors that should be considered when evaluating a potential straddle: time decay, implied volatility, and maximum risk. The straddle, as you know, includes a put and a call on the same stock. Both puts and calls have the same strike price and the same expiration months. The idea is for the stock to make a big move higher or lower. If it rallies, the call can begin to yield profits if it increases enough in value (in this case, $4.00 or more). If the stock tanks, the puts increase in value and can provide the profits. A big move in the near future is the best-case scenario.