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Option Trading Strategy

Straddle Prospects: Having established our trading risk profile for the longoption trading straddle trader anna straddle option trade, we now need to find some prospects in the underlying asset. In this case we shall be looking at equity options and therefore the underlying stock or share is key to our selection.

Naturally from time to time the markets are volatile, but waiting and hoping for some rapid price movements are simply not enough. We can certainly include an analysis of general market conditions in the process, our primary requirement is for underlying stocks or shares that are likely to move significantly in price in the next few months.

Options Trading: Straddle Prospects : Key Elements

In choosing our straddle option prospects, there are four elements that we have to consider and these are as follows :

Options Trading: Straddle Prospects - Stock Price

Each of these is important so let's consider each one in turn. Firstly the price of the stock. Wherever you trade a straddle the key is that we are looking for a large movement in price so we do not want to open the trade on a low priced stock or share. For my own trading, I would only consider US stocks with a price in excess of $25, and in the UK in excess of £10. Remember that you do not know or indeed care which way the price moves, just simply that it does, so give yourself enough room on the downside, should prices fall sharply. You don't want to be trading the straddle on a stock or share valued at 1 or 2 USD and find that price movement is restricted by the physical price.

Options Trading: Straddle Prospects - Trade Timing

For those of you familiar with options, you will know that the greatest enemy to you as an option holder is that of time. As expiry moves closer, the time value of the option erodes exponentially, eroding faster and faster with the value of the option falling as a result until at expiry the time element of the option is zero. The straddle strategy depends for its success on you giving yourself enough time for the trade to succeed.

However, time comes at a price, as the longer the option contact period, the more expensive will be the premium. I would therefore suggest for the straddle that you consider a maximum of 3 month contracts only - any shorter then time will work against you more quickly, and any longer then the trade becomes more expensive.

Options Trading: Straddle Prospects - Chart Patterns

We will look at this in more detail overleaf, but in essence we are looking for prices which are consolidating on the chart.

Options Trading: Straddle Prospects - Volatility

In an ideal world we are looking for three things here. Firstly we would like the HV ( historic volatility ) to be low, and  as we are looking at consolidating prices this is likely to the case. Secondly we would also like the IV to be lower than over the previous few months as this means that we are buying our options at an undervalued price ( in theory !) rather than at an overvalued price. Lastly we would also like the IV to to be lower than HV. Not much to ask!!

Now let's have a closer look at the trading chart patterns that we need to find in order to identify possible straddle prospects.

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