How to Trade a Strangle

Andrew Giovinazzi

Yo Pit Crazies,

Check out the 10 day chart of the SPDR Oil and Gas Explorer and Production ETF (Ticker: XOP):

Note that even in a strong bullish move, stocks can go down. I don’t know, nor care, why they go down, but after 30 years of doing this I know they can go down.

What’s more important for me in trading strangles or straddles is The Range. Floor trading taught me a lot of things, and as soon as I figured out how important the ATM straddle was, things went well. Fortunately that happened early, as I had good traders around me who knew what was up.

I was able to book a win here on Friday in XOP and keep a strangle for a credit until Jul21.

Let me show you how it was done.

What Does the Straddle Tell You?

Don’t make this complicated. The straddle tells you where the market thinks the stock can go between now and expiration.

The range is twice the straddle. The straddle is just the call and put at the money added together. In the snap below, that’s $2.75 for the call and $2.80 for the put on the midpoint, or $5.50 for straddle and $11.00 for the range. I’m looking for $134.5 upside and $123.5 downside.

XOP Jul21 option price from Jul 07, 2023 close

Now here’s the trick. If the underlying volatility stays constant and is the same as the option implied volatility, I should touch the ends of the range – up or down, sometimes both. Now, if the underlying volatility increases, my expected range grows, but the price I paid for the straddle will be the same since I already own it, even though the market price of the straddle can rise. That’s good.

Conversely, if the underlying volatility decreases, my straddle value will likely drop. Since I own it already, that’s not good.

In the case of XOP, I bought an XOP Jul21 134 call and 120 put strangle and leaned long into the upside momentum. I trade a strangle, long call/long put, with different strikes around the money when I want a direction with momentum.

During the big range, I sold most of my puts and calls for $2.80 with my entry price of $2.05. I held 4 contracts, so selling 3 left me with 1 strangle for a credit. I get paid to hold it until expiration. If oil flies, I profit.

Why did I close the calls on Friday? My strike was near the top of the range, and clearly the momentum I thought would happen didn’t exactly happen. XOP regained where it was, but my calls were still not back to my entry price. Selling the puts made the position profitable, so I took the sure money. The ranges held up well, so I just traded the range.

Close it when they want it, because tomorrow they might not want it.

The Rundown

Easy Button

iPath Series B S&P 500 VIX Short Term Futures ETN (Ticker: VXX) Jul14 24.5/27 strangle closed for a 50% gain Why did I close my puts for credits? The strike was at the end of the range so there was no real reason to hold them.