Ok, maybe I’m just tired or not thinking here, but why wouldn’t one simply purchase a call and put simultaneously and hope that the price moves significantly in one direction? The payoff profile the way I see it is a “V”, and as long as the stock moves sufficiently in one direction to cover the costs of the options, profit can be realized irrespective of the stock’s move (the only thing we’d hope is that the stock doesn’t remain idle and thereby lose out on the cost on both options). Can someone clarify why buying a put/call simulatenously wouldn’t generate profits? Thanks
Called a straddle, and alot of people do that. The option’s premium is generally priced so at the time of purchase, the “odds” of that being profitable aren’t good, and/or are justified by the seller’s asking price. If an investor believes the underlying will become more volatile than it currently is, the strategy is based on the investors future belief. Puts won’t rise in value as fast as calls, because puts have a limited max value, which also plays into it to an extent.
Here’s the link to wikipedia http://en.wikipedia.org/wiki/Straddle
as mentioned before called a straddle or strangle depending on the exercise price. for being long a straddle you are long call and long put. V-payout diagram why would it not generate profits all the time? assume you would buy it before the earnings release (hope the stock moves dramatically into one direction) and you cash in a huge profit. unfortunately this does not always work, since market makers price in the expected move = higher volatility in the premium. the option price goes up resulting in a high implied volatility. vice versa you can turn the option model around and solve the black-scholes-formula for the volatility given a market price. then you know what the big guys expect as volatility.
Beyond the payout diagram you can profit off of this position if implied volatility increases. The underlying price in this scenario could stay the same. Greater impllied volatility, greater chance of any price being hit -> greater straddle price.
I think a better, safer way given you have conviction in one direction over another, to do this is buying just in the money puts/calls and proportionatley buying/selling the stock against it. But your question above is summed up in the implied volatility…GOOG and AAPL are good examples, as options expiring near their earnings releases see the “wrong” side of the straddle collapse after earnings release