Explore Your Options by Tom Gentile
RSVP FOR A CHEAPER STRADDLE?
I like the idea of positioning with long straddles, but when it comes to pulling the trigger, Iím having problems executing. More often than not, the spreads that look the most attractive overwhelm me with the actual cost to initiate the strategy and/or the associated time decay. Can you offer any insight that might help me get over this barrier to entry?
Thatís a very good question to a situation many investors battle with in developing a trading plan. Your central dilemma seems to involve time and its impact on both shorter- and longer-term straddle pricing. This impact boils down to heightened concerns regarding increased decay risk when dealing with a near-term straddle versus a larger capital outlay and larger dollar exposure of the longer-term straddle if left unmanaged during the life of the contract.
For instance, if itís January and shares of Abc are at $35, the April 35 straddle might trade for about $3.50, while the February 35 straddle with one month until expiration is priced at $2.00. Over the next month, if shares sit or go nowhere, theta will eat up the entire value of the February straddle or $200 per spread.