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Using Option Straddle Information to Trade Equities Better

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Trading in equities requires a lot of skills that only a small fraction of people who attempt to do it fail. This is because very many factors lead to the movements of stocks. In addition, there are so many traders who have Harvard degrees and tens of years of experience in the industry. However, it is possible for anyone who is passionate, resilient, and willing to learn to become a successful trader. Options by comparison, are a bit complicated to new traders. They don’t understand how to place puts or calls.

 

There are many strategies traders use to make money in their trades. One of them is using options to predict the future price of a stock. The benefit of the internet is that it is possible for one to learn more about options and how to determine the sizing of trades. A good way of predicting a stock’s price, is using the straddles. Straddles are important because they give traders a view of anticipated market volatility. Remember, many traders make more money in periods of increased volatility.

 

Volatility comes in two kinds. These are implied volatility and historical volatility. Implied volatility is simply the estimate traders put into the price of a security. Ordinarily, the implied volatility rises when the market believes that a stock’s value will decline. It decreases when the market participants believe that the stock will go up in a period of time. The belief among investors and traders is that bearish periods are usually riskier than when the market is bullish. This is partly because the maximum level a stock can reach is infinite while the minimum level is zero. It is easier to get to zero than to an infinite number.

 

Conversely, historical volatility is the rate of change of a stock price. This is similar to how we measure a car’s speed in miles per hour. Normally, if a stock has a higher historical volatility, it means it has chances of more movements in the future. However, this does not specify the direction of the movement. It can either be in the bullish or bearish direction.

 

The long straddle strategy allows a trader to simultaneously buy a put and a call for the exact stock. Here is an example. Assume company A’s price for its stock is $30. You decide to enter a long straddle. Here, you buy a July 30 put for $300 and a July 30 call for $300. This means that you have a net debt of $600. On expiry, if the stock’s price is $40, the July 30 will expire in-the-money. It will have an intrinsic value of $900. When you subtract the debt of $600, you will have a profit of $300.

 

There are many advantages of using this strategy. The first advantage is that it has an unlimited profit potential. This is because when you have long calls and puts, you can have a huge profit no matter the direction of the chart. The diagram below shows a long straddle payoff diagram and how you can interpret the movements of the chart.

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Source: The Options Guide

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Another advantage of trading using this strategy is that it is less risky than other options method. This is because in an ordinary trade, your chances of losing money are 100%. In this strategy, your chances are 50%. This is because you have two open trades of the same underlying asset. In addition, there are usually two break even points.

 

This strategy requires a little bit of reading and practice. At first, it might seem as if it is an elite strategy where ordinary traders like you are not welcome. However, if you take time to learn and practice you have high chances of succeeding in option straddle.

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