Magazine article Modern Trader

Options Strategy

Magazine article Modern Trader

Options Strategy

Article excerpt

Question: How can you take risk off the table in front of an event without exiting your position?

Answer: Create a synthetic straddle

Options were created to help reduce risk or assist in the potential for generating an income on a current position. Over the years, many traders have found speculative uses for options. It was a natural progression as options are a great tool for creating very defined strategies, whether their goal is risk management or a safer speculative trade.

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With options you can take advantage of market movement or volatility. Using options for speculation works but many prefer to use them as they were originally designed.

Whether you are just learning about option strategies or you are a seasoned pro, there is a very good chance you have heard of, and maybe even executed, a straddle.

A straddle is a relatively neutral position that is created by buying an at-the-money call and put in the underlying at the same strike price, or selling an at-the-money call and put at the same strike.

If you purchase the at-the-money call and put you are long the straddle; if you sell the at-the-money call and put you are short the straddle.

Straddles, long or short, often are used around news events that can create spikes in volatility when a trader is uncertain as to where the underlying will go in the short term.

Think about an earnings announcement in the case of equities; crop report in terms of agricultural markets or GDP, CPI or unemployment in the case of financial futures. A report way out of line from expectations could initiate a stop or create a huge move against you in an existing position. However, you may want to hold onto your position for the long-term and simply want to take some of that short-term risk off of the table.

In a situation where we know that a news event is going to affect significantly the market we are trading, but we do not know what the outcome of the event is going to be or which direction it will move the market, it makes sense to neutralize a position. …

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