For investors who know how to use derivatives, each earnings release is a great opportunity to make money. But in the downturn of the market, with Google, Facebook, and other big tech companies reporting poor earnings. How can ordinary investors enter the market wisely without accurate judgment of specific earnings performance? Through the subtly use of straddle strategies, investors can earn from the undergoing volatility with low risks, while avoiding huge losses caused by judgment errors of stock movement.
How to Make Money by Options Straddle?
Take Tesla (TSLA.US) as an example. If Tesla's share price is subject to wild swings due to earnings announcements, is there a relatively conservative option trading strategy that allows investors to participate in the market with low risk and earn income even if they cannot accurately judge the ups and downs? Yes, that's the straddle option strategy.
A straddle is an options strategy involving the purchase of both a put and call option for the same expiration date and strike price on the same underlying security. This strategy is suitable for a situation where the underlying price is expected to fluctuate significantly, but the direction of fluctuation is uncertain, typically represented by growth stocks and technology stocks.
The strategy pays only a limited premium, and the potential gains could be huge in the event of a boom or bust. Noticeably, if the volatility is not large enough, you may lose the entire premium (the upfront payment of buying the option).
Example of Straddle:
Take the Tesla stock as an example. Assuming that Tesla stock is trading at $230 and earnings are scheduled to be announced on November 11. Then you buy a call option with a strike price of $230 due November 11 for $8.60; At the same time, buy a put option with a strike price of $230 due November 11 for $16.05.
Case 1: Suppose Tesla announces weak earnings results and Tesla's stock price falls to $200 on that day. At this time, the put option expires out-of-the-money and cannot be exercised, resulting in a loss of $1,605 in purchase cost. The call option is in-the-money and yields $2,140 (30*100-8.6*100), with strike price minus the purchase cost. So the portfolio gains $535.
Case 2: Suppose Tesla rises to $260 on that day as an optimistic earnings announcement. At this time, the call option is out-of-the-money and the loss is $860. The put option is in-the-money and the yield, strike price minus the purchase cost is $1,395 (30*100-16.05*100). So the portfolio gains $525.
There are two break-even points for a straddle strategy:
The low break-even point is equal to the strike price minus the total premium, and the high break-even point is equal to the strike price plus the total premium. A trader will profit from a long straddle when the price of the security rises or falls from the strike price by an amount more than the total cost of the premium paid.
- Low break-even point: $230- ($8.6+$16.05) =$205.35.
- High break-even point: $230+ ($8.6+$16.05) =$254.65.
When the stock price fluctuates Unapparent between 205.35 and 254.65, the investor is in the red. When the stock fell below $205.35 and rose above $254.65, investors began to make profits.
Similarly, the opposite of long straddle is short straddle, which means selling a call option and a put option with the same number, the same underlying, the same expiration date, and the same strike price simultaneously. The short straddle strategy is suitable for small volatility.
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