Monday Options Thoughts: Straddles and Strangles

What a volatile morning so far! Indexes are selling off and bouncing back; stocks such as ImClone (IMCL | Quote | Chart | News | PowerRating), Novartis (NVS | Quote | Chart | News | PowerRating), and General Motors (GM | Quote | Chart | News | PowerRating) among others are very active with economic and company news flowing quickly across the wire.

Mornings like this have me thinking about simple, non directional option strategies that profit from volatility regardless of the direction of the underlying stock.

Yes, you heard that correctly, there are simple strategies that will book you profits regardless of the directional movement of the stock. The stock simply has to make a decent move within the time frame of the options in the strategy.

These strategies are called straddles or strangles, they are ideal for high volatility stocks where the direction is unknown. For example, you know a drug company will be making an announcement about a new drug or earnings are being released but you don’t know if the news will positively or negatively effect the stock.

Using a straddle or strangle is the ideal simple option strategy for these types of situations.

What are Straddles and Strangles?

Simply put, Straddles and Strangles are strategies to use when you believe a stock will make a big move but are unsure of the direction.

Specifically, a Straddle is long one call and long one put at the same strike price/expiration date on the same date. A Strangle is long one call at a higher strike price and long one put at a lower strike at the same expiration/same stock.

One can also short Straddles and Strangles, however, this exposes the trader to unlimited downside risk and is only recommended to advanced option traders. Going long, as described above, has limited risk but unlimited profit potential. However, remember a move big enough to absorb the losing side is needed to profit, so these two strategies are only used when you expect a large move in one direction or the other.

For example, let’s say that you believe ImClone will make a sharp move over the next several days, but are not certain of the move’s direction. A long Straddle would be buying a June 40 Put and buying a June 40 Call. A long Strangle would be buying a June 45 Call and buying a June 40 Put.

Good luck!

Dave Goodboy is Vice President of Marketing for a New York City based multi-strategy fund.