Risks of Long Straddles and Strangles
💡 Mastering Risk: Long Straddles and Strangles
In this lesson of the Masterclass, you will learn about:
- Risks of long straddles
- Risks of long strangles
- Understanding and managing them
- Important considerations for both
A long straddle involves buying a call and a put option on the same underlying cryptocurrency, both with the same strike price and expiration date. This strategy profits from significant price movements in either direction and is a bet on increased volatility.
Risks of Long Straddles
- Lack of Significant Price Movement: The primary risk with a long straddle is that the underlying cryptocurrency remains range-bound, causing both options to lose value over time due to theta decay.
- Decrease in Implied Volatility: After purchasing the straddle, a decrease in implied volatility can reduce the value of both options, leading to potential losses even if the underlying price moves.
- Cost of Entry: Long straddles can be expensive to set up, especially if options premiums are high due to elevated implied volatility.
Managing Long Straddles
- Timely Exit: If the underlying starts to move significantly in one direction, consider taking profits on the profitable leg and letting the other leg run or closing it to reduce further losses.
- Rolling: If the underlying remains range-bound as expiration approaches, consider rolling the straddle to a further expiration date to give the position more time to profit.
- Diversification: Implementing long straddles on different cryptocurrencies can help diversify risks, especially if certain assets move while others remain stagnant.
Long Straddle: The primary threat being theta decay, the straddle will gradually lose value if the underlying cryptocurrency remains range-bound.
A long strangle involves buying an out-of-the-money call and an out-of-the-money put on the same underlying cryptocurrency, both with the same expiration date but different strike prices. This strategy also profits from significant price movements in either direction but typically costs less to set up than a straddle.
Risks of Long Strangles
- Lack of Significant Price Movement: The primary risk is that the cryptocurrency remains within the range defined by the two strike prices, causing both options to lose value.
- Decrease in Implied Volatility: A drop in implied volatility can erode the value of the options, making it harder to profit even with a significant price move.
- Time Decay: Being a long volatility strategy, the passage of time, especially as expiration nears, can erode the value of the options.
Managing Long Strangles
- Timely Exit: If one leg of the strangle becomes profitable due to a significant price move, consider taking profits. Depending on market sentiment, you can also let the other leg run or close it to prevent further losses.
- Rolling: If the underlying remains within the strikes as expiration nears, consider rolling to a further expiration or adjusting the strikes to reflect the new price range.
- Diversification: Using long strangles on a variety of cryptocurrencies can spread risk and increase the chances of capturing a significant price move in at least one asset.
As with the risks for other options strategies, both long straddles and strangles come with a set of important considerations.
1. Liquidity Concerns: Trading in illiquid markets can lead to significant slippage, especially when trying to exit or adjust positions. It's essential to ensure that the chosen cryptocurrency has a sufficiently liquid options market.
2. Regulatory and Platform Risks: Sudden regulatory changes or platform-specific issues can introduce unexpected volatility. While these strategies profit from volatility, unforeseen spikes can lead to rapid adjustments or exits, which can be challenging in illiquid markets.
3. Skew and Surface Analysis: The implied volatility surface can provide insights into market sentiment. A pronounced skew towards calls or puts can indicate bullish or bearish sentiment, respectively. Understanding this can help in selecting appropriate strike prices and gauging potential price moves.
4. Monitoring Implied vs. Historical Volatility: Comparing implied volatility (IV) to historical volatility can provide insights into whether options are relatively expensive or cheap. If IV is significantly higher than historical volatility, it might indicate that options are overpriced.
What happens to a long strangle in a stagnant market?
The straddle ¨rises in value with the passage of time.
In a stagnant market, the value of a straddle remains stagnant.
Its primary threat being theta decay, the straddle will gradually lose value if the underlying cryptocurrency remains range-bound.