Here are some guidelines to identify key criteria to a successful straddle trade:
1. Stock price must move within the target time frame
The stock price will need to move up or down sufficiently to offset the loss of time value in the call and put that form the straddle.
Remember, theta is the main enemy of a successful straddle trade.
A good way to achieve a profit within an acceptable time frame is to use an options calculator to determine the necessary price movement needed.
2. Identify upcoming events
Identify an upcoming event that could significantly impact the price of the stock.
The event needs to be such that good news will lead to a rise in stock price, and vice versa for bad news.
Examples are earning announcements, court decisions and FDA rulings.
3. Have ample expiration date
The expiration date should be sufficient to allow the upcoming event to occur and produce the necessary price movement.
4. The upcoming event must not generate interest yet
The upcoming event must not generate enough excitement to cause the options price to be overly infalted.
These can be judged in several ways:
- Level of open interest
- Trading volume of the options
- Current implied IV of the options against historical averages.
5. Look for a stock that has been trading sideways within a narrow price range
This signifies an even battle between buyers and sellers of the stock.
When the price breakouts, either up or down, option prices will gain extra time value and produce an increased potential profit in the straddle.
When you’re in a straddle trade, here are some guidelines to exit the trade:
1. Sometimes it is better to exit one side of the trade first
There are times where it will be best to exit one side of the straddle trade before the expected event occurs.
An earnings run is one example. The stock price may move up sharply just prior to the scheduled earnings announcement. In this case, it may be wise to take profit on the call leg first and hold the put until after the earnings announcement.
If the stock price falls after the earnings announcement, the exit price for the put will be better.
2. Do not stay in the straddle too long
After the event has taken place, do not stay in the straddle too long.
If the event causes a significant move in the stock price, it may pump extra time value into the price of the profitable option temporarily. Sell this option before the extra time value shrinks.
3. Nover hold both sides of the trade until expiration
If nothing happened to create a price move, the straddle will lose a substantial portion of it value during the last 3-4 weeks of its life.
As such, exit early when there is at least 3-4 weeks before the options expire to cover early.
It is recommended that straddle options have at least 30 days of expiry time left after the expected event to capture as much value of possible.
Otherwise, holding options near expiration generally lead to a losss on the trade.