Introduction
If you are sure that the underlying stock/index is going to move strongly before expiration, then this is the option strategy for you. The move can be in any direction, as long as its violent. For example, you might be expecting an important court ruling, the outcome of which will be either very good news or very bad news for the underlying.
Remember that most of the obvious uncertainties are priced in. So you better have a unique point of view.
Construction
This strategy consists of buying a call option and a put option with the same strike price and expiration, making it relatively expensive. The options are struck ATM (at-the-money.)
With the NIFTY trading at ~6780, you can either buy the 6750 straddle or the 6800 straddle. Let’s walk through each trade.
May Nifty 6750 long straddle
Note the θ (-742.73) on the ITM call. Its a lot of time-decay if you are wrong. The model says that the market prices are too disjointed from the model price. Besides, the break-evens are 6161.00 and 7339.00 which means that you have to be absolutely convinced that something big is going to happen.
May Nifty 6800 long straddle
The θ situation has improved somewhat and the break-evens – 6217.20 and 7382.80 – look better. The trade costs Rs.29,140/- to put on and that caps your max-loss.
Exiting the trade
Time is not your friend here. You can either exit the trade right before the event occurs – when implied volatility is at its highest or soon after the event (irrespective of the magnitude of the movement.)
The lack of liquidity means that you are forced to put this trade on closer to expiry and that is exactly the time when θ-decay is at its highest.
Related articles
- Options Liquidity (stockviz.biz)
- Forensics: NIFTY Options – Theta(θ) Decay (stockviz.biz)
- Forensics: NIFTY Options – Vega(κ) (stockviz.biz)
- Forensics: NIFTY Options – Implied Volatility(IV) (stockviz.biz)
