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Straddles With No Upside Risk

Market Measures

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

An IRA account may not be short a Straddle because such accounts are not allowed to be short naked calls due to the undefined risk nature of the strategy. By adding a long upside call we enable the strategy to be performed in an IRA account and decrease the margin requirement and risk in a margin account. When the total credit collected is greater than the distance between the call strikes (and there is therefore no upside risk) LIZ and JNY refer to this as a “Big Lizard".

We ran a huge study to determine the best strategy for managing such trades. The study was conducted using SPY (S&P 500 ETF) from 2005 to present (2,700 occurrences). We sold an at-the-money (ATM) Straddle and bought the furthest out-of-the-money (OTM) call that allowed us to collect a credit greater than the width of the call spread. We then examined holding the trade to expiration, exiting at 25% of max profit and at 1x, 2x and 3x times the credit as loss management.

Managing the winners at 25% was clearly better than waiting until expiration so we then tested managing at 25% against managing at 25% while also managing losses.

Watch this segment of “Market Measures” with Tom Sosnoff and Tony Battista for the valuable takeaways, the detailed study results and other insights on how to best manage a short straddle with upside protection.

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