Factors to Consider When Using Straddles - dummies

Factors to Consider When Using Straddles

You can create a straddle when you simultaneously buy a put and a call for the same stock at the same strike price and of the same duration. Keep in mind that there are some important factors that you should consider:

  • Establish your straddle at least a day before the release of the data. You can do it at the close of regular trading, or by using Globex in the overnight session. If you own a call option and a put option on the U.S. 10-year T-note futures, the call will likely rise in price as the put falls when the market responds to the Consumer Price Index (CPI) report. As the put falls, you can sell it (and take your loss) and review your choices of how to capitalize on the opportunity provided by the call.

  • Build multiple strategies simultaneously. Because long- and short-term interest rates can move in opposite directions in response to news from economic reports, you can build other strategies (in addition to your T-note straddle) by using other options and contracts to build another straddle using Eurodollars, which are short-term interest-rate instruments. The T-note straddle is a long-term interest play. If you set up a straddle for T-bills or Eurodollars, you’re setting up a play on short-term interest rates.

    You can also use the same kind of straddle strategy in the currency markets for the same trade, although doing so may be a bit more difficult than hedging your bets in the interest-rate and stock-index contracts.

Time works against you in the options market. Don’t assume that you can sell the part of the options straddle that’s going against you right away without first considering the possibility of managing the position. For example, holding onto the put option, even if the market moves in a way that makes your call option more profitable, may be the right thing to do. After a short period of time, the market may reverse itself, and at that point, you can take profits on the call and see what happens with the put.