If yes, what will it look like?
Let’s answer in detail today.
We know that there are two types of options — call and put — and both are opposite to each other. So, by mixing them we can generate setups that will make money irrespective of the direction of the market.
Let’s look at classic setups:
Long Straddle and Long Strangle:
This is a strategy used by traders in case of an event where the date of an event is known but the outcome is unknown.
Examples of such events can be election results, AGM of a company, Budget announcements etc.
In such events, we are not sure of the outcome of the event, but one thing is sure the market will go up/down heavily.
In such cases, to capture rallies on both sides we buy ATM CE and ATM PE together.
So, if the market goes up call will give us a big profit, and put will give us a small loss (Option buying gives unlimited profit and limited loss)
Similarly, if the market goes down, the Put option will give a big profit and the call will give a small loss.
Thus, irrespective of the direction, if the move is big, the trader walks out with good gains.
Note: The move has to be really big (2-3% in Index and 7-10% in stocks) else, due to premium decay on both call and put, the strategy will give a loss and hence it is performed only during events where the probability of moving big on any side is high.
Similarly, if we buy OTM CE + OTM PE, the same strategy will be called Long Strangle.
This is also event-based and it will also give profits if the market goes either up or down by a big number.
After discussing long straddle and long strangle, let’s discuss short straddle and short strangle.
Short Straddle and Short Strangle
The short straddle will be opposite to the long straddle. We short ATM CE + ATM PE, and will work opposite to long straddle, so this is performed when we are expecting the market to be flat. There will be premium decay in both call and put.
Similarly, if we short OTM CE+ OTM PE, this setup will now be called Short Strangle and this will also give gains only when the market is flat or range bound.
Note: Long straddle and Long Strangle are option buying setups and need less capital to deploy, whereas Short straddle and Short strangle are option writing setups and need more money and can be very risky if the market goes in either direction.
Similarly, a trader can create his/her own option strategies using multiple strikes of call and put.
We will discuss a few more setups in the next article.