Optionetics: BACK TO BASICS: Using the Synthetic Straddle with Calls
OPTIONETICS.COM WEEKLY NEWSLETTER
10/24/2005
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MAJOR INDEX CLOSINGS FOR THE WEEK
10/17/2005 - 10/21/2005
Closing Change % Change
NASDAQ (COMPQ) 2082.21 11.91 0.58%
DJIA (INDU) 10215.22 (132.88) (1.28%)
S&P 500 (SPX) 1179.59 (10.51) (0.88%)
Market Volatility (VIX) 16.13 1.46 9.95%
View our complete listing of the indices.
http://quotes.optionetics.com/optionetics/indices.asp
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BACK TO BASICS: Using the Synthetic Straddle with Calls
By Jeff Neal, Optionetics.com
10/24/2005 9:00:00 AM
The long synthetic straddle is considered to be a delta neutral strategy that can be implemented using puts or calls. The strategy is very flexible because the trader has the capability of increasing profits by making adjustments as the market makes its move. The long synthetic straddle essentially combines options with stock, and as the market breakouts either up or down, the trader can generate profits in both directions.
With this type of position it is important to understand that one leg of the trade will lose money as the other makes a profit. The difference between the profit and loss determines how much the net profit or loss will be. Of course, a variety of factors determines how much net profit is generated, such as the size of the account, the size of the trade and if the trade can be adjusted to get back to delta neutral after the market makes a move.
As mentioned earlier, the long synthetic straddle can be used with either puts or calls. In this article we will demonstrate how this strategy is implemented employing calls. When using calls the trader would sell short the stock and then purchase call options to create an overall delta neutral position. When the market goes up, the trader will incur a loss on the underlying stock but would have a bigger profit on the options. When the market goes down, the trader would have a profit on the underlying stock and a smaller loss on the options. No matter the direction, as long as the market moves beyond the breakevens the trader will receive a profit.
When employing long synthetic straddles the option strategist needs to find a market with low volatility where it is anticipated that there will be volatility increase resulting in stock price movement in either direction beyond the breakevens. The trade is implemented by buying 2 long at-the-money calls for every 100 shares of XYZ stock that is sold.
The maximum risk on this type of trade is equal to the net debit of the options plus the options strike price minus the price of the underlying stock then multiply this result times 100. The maximum reward is unlimited to the upside and limited to the downside as the underlying stock can only decline to zero beyond the breakevens. The downside breakeven is the price of the underlying stock minus the net debit of the options. The upside breakeven is 2 times the option strike price minus the price of the underlying stock; then add the net debit of the options to this result.
The beauty, of course, of these synthetic straddle positions whether employing puts or calls is that that it is less costly either in cash or margin requirements than simply purchasing or selling stock outright. In addition, the long synthetic straddle permits easier adjustments to the trade as conditions change. This strategy is certainly worthy of putting in your arsenal because it is a very powerful trading vehicle.
Happy Trading.
Jeff Neal
Senior Writer, Options Strategist & Profit Strategies Radio Show Market Correspondent
Visit Jeff's Forum
http://www.optionetics.com/bbs/forum.asp?forum_id=141&forum_title=Ask+Jeff+N
Listen to Jeff at www.ProfitStrategiesRadio.com
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PROFIT IN TODAY'S VOLATILE MARKETS
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WEEKLY OUTLOOK: Oct. 24
http://www.optionetics.com/articles/article_full.asp?idNo=13506
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BACK TO BASICS: Using the Synthetic Straddle with Calls
With this flexible strategy you can increase profits by making adjustments as the market makes its move.
http://www.optionetics.com/articles/article_full.asp?idNo=13508
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INTERVIEW CENTRAL: John Person, Part II
The conclusion of Jeff Neal's chat with this accomplished author and veteran of the futures and options trading industry.
http://www.optionetics.com/articles/article_full.asp?idNo=13497
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TECHNICAL TOOLBOX: Results & Review of Sample Trading System
A review and evaluation of the results of the trading system Clare White proposed last week.
http://www.optionetics.com/articles/article_full.asp?idNo=13496
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VOLATILITY ALERT: Mixed Week for Stocks and Fear
Earnings news has been the big story this past week, which has stirred up a lot of volatility.
http://www.optionetics.com/articles/article_full.asp?idNo=13503
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TECH WORLD: China Mobile�A Opportunity to Profit From China�s Growth
The latest quarter results saw revenues shoot up 33 percent and net income increase more than 18 percent.
http://www.optionetics.com/articles/article_full.asp?idNo=13498
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Thank you, have a great week and good trading!
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posted by Victor Lloyd Smith @ 4:56 PM
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