A "Straddle" is a type of options strategy that aims to profit from market volatility regardless of the direction of price movement. In simpler terms, a Straddle involves buying both a call and put option with the same strike price, creating a neutral position. This strategy can generate profits if the market moves in either direction, but the profits are not realized immediately; rather, they occur after the market has passed certain price points.
The point of creating and applying a Straddle option strategy is to take advantage of potential price volatility in an underlying asset. By purchasing both a call and a put option, the investor can profit regardless of whether the price of the underlying asset goes up or down. If the price moves significantly in either direction, the investor can exercise the corresponding option and profit from the price difference. This strategy allows option traders to benefit from large price swings without having to predict the direction of the movement.
This is the typical definition and objective of this strategy, commonly found in every options trading book and website. In the scenarios mentioned, it appears that someone invested millions in Straddles purely on the expectation of increased volatility and significant price swings in the underlying asset. Seriously? Is there really no contingency plan in place? However, let me share the lesser-known aspects of this strategy and its true value, as practiced by the seasoned pros on the trading floor.
But first, there is a chart of the Japanese yen
On October 25th, a Straddle setup emerged on the Japanese yen futures, with a short expiration date slated for November 1, 2024. After that, the break-even points were applied.
And then the quotes acted like this…
Was it possible to benefit from this information for trading? Yes, it was indeed possible to leverage this information for trading. For instance, one could have opted against opening a short position at the lower boundary of the Straddle since the price is likely to remain within this range.
However, it is essential to recognize that the use of Straddles is not based solely on hope for increased volatility. Professional market participants typically have a well-defined plan, often integrating graphical and another analyses to reflect the behavior of less informed market participants.
Take a look, on August 6th, an another significant Straddle option portfolio was listed on the Chicago Mercantile Exchange (CME).
The boundaries of this portfolio, indicated on the provided chart, represent reasonable entry points for the portfolio owner. Observations suggest that the price tends to bounce off these boundaries, which can be used to enhance trading strategies, particularly in the direction of the current trend.
A few days later…
The Straddle boundary was reached, resulting in a perfect rebound. It appears that the Straddle has once again proven effective, allowing us to open a short position aligned with the current trend. The move from the boundary to the profit side has exceeded 160 points, so we’re moving the trade to breakeven. Great! We entered the downtrend with pinpoint accuracy.
To understand how a holder of a Straddle option portfolio can earn from price movements that stray from the boundaries of the Straddle, we need to explore the concept of synthetic positions in options trading.
Synthetic Positions
A synthetic position is created by combining different call or put options and futures.
Formula for Synthetic Positions
Synthetic Long Call Position:
- Formula: Buy a Put + Buy a Futures (at the break-even point )
- This position mimics holding the Long Call. If the price of the underlying asset rises, the call option increases in value.
Synthetic Long Put Position:
- Formula: Buy a Call + Sell a Futures (at the break-even point)
- This position mimics holding the Long Put. If the price of the underlying asset falls, the put option increases in value
The holder of a Straddle already possesses a long call and a long put, which means he should only buy or sell futures at the breakeven points. This results in break-even synthetic call or put. In other words, even if the price moves beyond these boundaries, holder won't incur a loss. However, if analysis is accurate, the potential profit can easily surpass the premium paid for the Straddle.
CONCLUSIONS:
- Professional traders and "smart money," often utilize the Straddle strategy around break-even points or 'break-points.'
- Using those boundaries increases the accuracy of your input and, therefore, leads to a better P/L (profit/loss) ratio.
- The significance of the Straddle boundaries is higher if there is a match with other patterns and levels
This strategy is not just a “volatility gamble”, it is a calculated approach employed by knowledgeable market participants. For forex traders, it's crucial to evaluate the price and chart levels where the breakeven points of a Straddle are situated.