Volatility Option Strategies - 9 Trade Selection Rules for Straddles

This trading tutorial, part of the program “The Secrets of Options Strategies”, explains how to select a straddle successfully in the market and at which conditions it is convenient to trade.

How to place the most rewarding options strategies from scratch? Visit my website at www.FromZeroToOptions.com to get tutorials, instructions, articles and much more stocks and options related.

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Here are listed all conditions and rules any trader needs to follow when trading complex option strategies as a straddle.

1. Pick ATM options

Consider only ATM options trying to create a position as more delta zero as possible with the two breakeven points at the same distance when the position is open.

2. Pick options with 3 or 4 months before expiration

Consider options with three or four months before expiration. In fact, above 120 days options may be too expensive for this neutral strategy; conversely, below 90 days, you may have not enough time to be right on this trade. Remember that in a straddle time decay is against you, so you never want to own options in the last month before expiration.

3. Pick stocks whose price is within a range

Select stocks whose price is higher than $20 and lower than $60. This may be necessary because a straddle is an expensive strategy and you want to avoid paying a too much high premium. This is the range of price many professional traders recommend and that, in my experience, I have found more profitable and cheaper to trade. Anyhow, if you feel comfortable with, you can choose a different range of price.

Free Tutorials - Stocks, Options, ThinkorSwim and more.. Click Here!

4. Take notice of incoming news event causing strong expectation on masses

Take into consideration any news or announcement that can have a relevant impact on a stock. Typically, such events (earnings release, government reports, lunch of new products, new management, takeovers, etc.), which might be considered as a catalyst event, are sign of a big move on the underlying. Rumors are around and cause a rise in the trading volume of a stock, because of people expectations. People are expecting something to happen and this may have the effect to potentially determine a rise in volatility and an explosive movement. What you don’t know is the direction of such move. Even if the expected event didn’t happen, there may be a consistent move determined by people disappointment or relief.

5. Pick options with low implied volatility

Look for stocks with low implied volatility. You need to find cheap options to buy. Check the charts of the implied and historical volatility in ThinkorSwim and compare their trend for the last year. For further information, see the free trading tutorial Studies.

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Do not forget to visit my website at www.FromZeroToOptions.com to get tutorials, instructions, articles and much more stocks and options related.

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6. Check the mathematical feasibility of the trade

Before getting into the trade, consider doing a simple mathematical calculation to make sure of its feasibility. For instance, if you consider trading a straddle on options with 120 days left, you should go back 20 days for each month (in this case 80 days) and identify the stock High and Low for this time (80 days). At this point, the calculation to perform is the stock recent high less the stock recent low divided by two (high - Low/2). In order to be feasible, the cost of the straddle has to be less than the result of this calculation.

7. Look for consolidation patterns such as triangles, pennants or flags

Perform a technical analysis of the stock. You don’t need to have a lot of experience on this, but a little is necessary as to identify patterns. You need to find stocks that are experiencing a consolidation pattern such as pennants, flags or triangles. Or at least, you need underlying securities which are moving sideways with low implied volatility and that are about to move explosively in relation to incoming news.

8. Don’t trade straddles too often

Look for stocks with small slippage between ask and bid. You need to keep the price you pay low and avoid to be buying and selling the same straddle too often.

9. Utilize technical indicators such as the ADX to measure the strength of a current trend

In order to trade a straddle successfully, you may found useful to use also some momentum indicators. One I have found by reading George Fontannils’ best seller “The Option Course” is the Average Directional Movement Index (ADX). This oscillator measures the strength of a current trend and fluctuates between 0 and 100. Readings below 20 indicate that the stock is moving in a range; while readings above 40 indicate a strong trend in either direction. Since you are interested in trading a straddle, you should look for a weak trend (lower than 20) and, by helping yourself with the stock chart and the other selection rules previously shown, try to catch clues that the weak trend is ending and a strong trend is coming. For instance, a stock whose ADX begins to rise above 20, may offer you a signal that a strong trend either upward or downward is approaching. On the other hand, if the ADX begins to decrease below 40 may indicate the end of a previous strong trend.

Before trading a straddle, you must always respect the above mentioned rules in order to be able to find the market conditions that make higher the likelihood to be profitable.

Free Tutorials - Stocks, Options, ThinkorSwim and more.. Click Here!

In the next GroWithYou Trading Tutorial:

• The Straddle Screening Activity;
• How to Perform a Manual Scan Activity for a Straddle.
  

Keep learning about Options Strategies by going to:

• How to Find a Profitable Straddle - Screening Techniques and Manual Scan Activity

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