Google Trading System - Straddle and Strangle

Straddle and Strangle

The above graph shows the Strangle and Straddle profit and lose graph on the expiration day.

Basically the P&L graph shows that:

Strangle
Move > 620 + call and put option bought price = Make money
Move < 610 - put and call option bought price = Make money
Move within 610 and 620 = Lose Money (Maximum lost is the bought price of call and put option.)

Straddle
Move > 620 + call and put option bought price = Make money
Move < 620 - put and call option bought price = Make money
Move within 610 and 620 = Lose Money (Maximum lost is the bought price of call and put option.)

Note: Decreases in IV will decrease the option premium regardless of the underlying stock.

Important factors to consider …

- IV of the stock (IV = Implied volatility)
- Debit of the put and call (520 call – 510 put = 10 bucks debit)
- Option Greeks (Theta and Vega) (extrinsic value = Time + IV)
- Daily traded range of the stock
- Time Factor (which months contract to buy?)
- Total Slippage of the option (put/call)

IV of the stock

Always buy the low IV and sell at high IV. You can check out the history of IV using Optionsxpress volatility view. I still can’t find a better free site to check about IV. You guys might want to check out on http://www.ivolatility.com. Once again BUY LOW IV SELL HIGH IV.

Debit of the put and call (520call - 510put = 10 bucks debit)

Smaller debit = Easier for your strangle/straddle to break away from the breakeven point.

Options Greeks (Theta and Vega)

Theta determines how much money to you has to pay everyday. Let say the Theta of GOOG 620 option is 0.1. This mean everyday the GOOG 620 option will be losing 0.1 values. Theta will change as the stock price changes.

Vega determines how much money the option will make or lose from the IV of the stock. Example …

Today - Google IV is 50%, GOOG 620 call option has Vega of 0.2, Google stock price is 620.

The Next day - Google IV is 52%, GOOG 620 call option has Vega of 0.2, Google stock price is 620.

As you can see everything remain the same except the IV. The IV from 50% increases to 52%. This mean a 2% of IV increases. Which translate to 0.2 (Vega) * 2 (IV) = 0.4. This simply means that if the IV increases by 2%, the option value will increase by 0.4. This also means that if the IV decreases by 2%, the option value will decrease by 0.4.

This will happen regardless to the stock price. The Vega will change accordingly to the stock price.

Daily traded Range of the Stock

The daily traded range of the stock has to be as high as possible. For example, Google is trading at a range of 10 bucks daily. If you have a high daily range, the Strangle should profit within a shorter period of time in respect of the stock price only.

Time Factor (which months contract to buy?)

You have to decide which month of the strangle/straddle you want to buy. The time factor is not a hard and fast rule. You just have to estimate how long it will take the stock to move beyond the breakeven price.

Buying a longer period of months will not necessary benefit you as you have to pay more for it. Buying a shorter period of months as your stock might not be moving as fast as you wish. This is quite an important factor to consider. So think carefully.

Slippage of the option (put/call)

The total slippage of your put and call should be as low as possible. The lowest you can get is 20cent. The maximum slippage for trading Google is 60 cents. More than that no go. Different stock will have a different maximum slippage so is really up to you to decide. So buy properly.

Why do I love to use straddle/strangle on Google

I use the option strategy strangle/straddle on Google very often as it love to move up or down aggressively. It is a very crazy animal. I used to have a hard time catching and taming Google. So I just give up on it and just let it run whichever direction it love to run. By doing so, I come out with my strangle/straddle. Just strangle it.

I had use construct this strategy hundred over time in paper trading. I had make real money too from strangling Google and BSC. People also benefit from this simple strategy. This strategy will not always work for Google as the nature of the stock behavior will change as the time passes. Be flexible and understand the key factor, which will make this strategy so powerful.

History of the Google Trading System

This is the first edition of Google Trading System (GTS) which is invented by me after a series of back/forward testing and trial on the real market. Before i reveal my Google Trading System, I would like to make some disclaimer:
This system is created to suit my trading style, thus it might not be suitable for other people. I will not be responsible for any losses that you have acquire in the event of using my GTS.

Google Trading System aka GTS

The first strategy that i use in the Google trading system is the safest among the rest of the strategy. This is how the first strategy works; GTS

If Google stock trading at let say now 510, I will buy a call option of 500 and a put option of 520. So that means i will buy both deep in the money. When Google hit either 500 or 520, you will have money because either your call or your put will make more than the other.

Why is this so?

When let say Google from 510 rises to 520, Your call position will be deep deep in the money and your put position will be out of the money. Thats mean your call position will earn more money than your put can lose.

This strategy also known as Strangle …
The strategy involves buying an out-of-the-money call and an out-of-the-money put option. A strangle is generally less expensive than a straddle as the contracts are purchased out of the money.

For example, imagine a stock currently trading at $50 a share. To employ the strangle option strategy a trader enters into two option positions, one call and one put. Say the call is for $55 and costs $300 ($3.00 per option x 100 shares) and the put is for $45 and costs $285 ($2.85 per option x 100 shares). If the price of the stock stays between $45 and $55 over the life of the option the loss to the trader will be $585 (total cost of the two option contracts). The trader will make money if the price of the stock starts to move outside of the range. Say that the price of the stock ends up at $35. The call option will expire worthless and the loss will be $300 to the trader. The put option however has gained considerable value, it is worth $715 ($1,000 less the initial option value of $285). So the total gain the trader has made is $415.

For GTS , i modify the strangle strategy a bit as i buy ITM call and put. The logic behind this move is because the daily range of Google is about 10 bucks. ITM call and put will move faster than OTM call and put.
In conclusion, When you see that you have already making money from this strategy, you just take the profit. This strategy normally will be profitable in less than 2 days. I call it the risk free or only 10% of risk as Google will always move either up or down. My this simple strategy dun work only when Google dun move as in going sideway.
Please test it out on virtual trading first to have a look at the power of options strategy and my GTS =) before you put it in real money. Happy trading and i will slowly publish with the other GTS which can make more money but of higher risk if you do not know how to do it.

Useful comment by JACK

I have seen Lawrence’s analysis on the Greeks and just like to comment on one common misconception about traders who are not familiar with synthetics:

Lawrence said “For GTS , i modify the strangle strategy a bit as i buy ITM call and put. The logic behind this move is because the daily range of Google is about 10 bucks. ITM call and put will move faster than OTM call and put.

In conclusion, When you see that you have already making money from this strategy, you just take the profit. This strategy normally will be profitable in less than 2 days. I call it the risk free or only 10% of risk as Google will always move either up or down. My this simple strategy dun work only when Google dun move as in going sideway.”

Actually this is precisely what I meant by misunderstanding about the synthetics. Let me put this right:

A Strangle using OTM calls and puts are synthetically the same as a strangle using ITM calls and puts. Sometimes, it may be better to use OTM options because the bid/ask spread can be wider for ITM options. So, there is a slight advantage in using OTM options for a strangle strategy.

And if Lawrence can understand this, he will not need to use so much capital per trade because it is no point in my opinion to park intrinsic value with the market which does not make any money there from.
A better strategy than GTS will be gamma scalping. However, if one were to gamma scalp on GOOG, unless he is able to enjoy the new margin rule, the capital outlay will be very expensive. In fact, in my view, gamma scalping is more suitable to Lawrence’s day-trading style because gamma scalp does require one to adjust the delta every time when the underlying makes a move beyond the “expected move”. Also, it does not require the straddles/ strangles to be close and open everyday. It will certainly save commission costs.

Anyway, it’s just my comments from pure options perspective. I still admire his system development mindset!
Using Aug options chain as an example to prove my earlier points:GTS

Take note that a 510 P has 35 delta while a 530 C has only 17 delta. If this is purely a 1 to 1 strangles, then it is not delta neutral, and also not gamma neutral at the open. If GOOG tanks, the 510-530 Strangles will make money much faster than the other direction. So, suggestion is to use 1×2 strangles to make this trade at least slightly delta neutral.
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Jack i got what you mean by

- A Strangle using OTM calls and puts are synthetically the same as a strangle using ITM calls and puts. Sometimes, it may be better to use OTM options because the bid/ask spread can be wider for ITM options. So, there is a slight advantage in using OTM options for a strangle strategy.

Yup i know the bid/ask spread is wider for ITM options. Usually what i did was i make sure both my call and put will lose the same amount of money when i buy both of them which is abit hard for google.I have to test out the OTM system and yup with closer slippage will be easier to buy too.

Seriously when i come out with the GTS 1 which is the simplest and less risk in my system, i never consider the delta as i thought should be roughly the same. With the OTM i really dun need 10k account to trade GOOGLE which is good. =)
I have to go test it out myself to see again.

Thank you very much and i will refine my Google system to get better % of earning money and reduce the risk hehe ;D
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Just to add on to my GTS, this system is i develop while im trading google. Thus it is kind of suit my trading system which i use to make money day in and day out. So i will refine it to suit most of the people. I really appreciate Jack comment as i really didnt know much about Option Strategy. I’m still in a learning process and also because i haven’t reveal the rest of the GTS which i have GTS2, GTS3 and some other which are alot higher risk than the GTS1 but if you combine everything together it will be very powerful.

21 Comments

1. ddarius on August 13th, 2007

I’ve been waiting to see this post for quite some time!! I’d always thought you only scalp GOOG!! Coolz… Please share more about GTS!! Anyway, so GTS involves buying ITM call/put one strike price away from the share price, but what month do you advise? Current month?? Next month?? 2 months??…
Strangle strategy is interesting… any idea where to read about straddles??

2. akalawoo on August 13th, 2007

At first i scalp google in one direction. Then i realise it is not very safe and i have to keep up with the trend which can go very fast. The more i trade/scalp on google, i realise that it will always go up and down which i can profit both way. Thus i come out with the GTS which give me a safest way of trading google.
For me i buy current months, but that is because i dun just use the simplest strategy. I use quite a few of the strategy.
For the simplest strategy GTS1, i would recommend you guys to buy the next months.
you can read about straddles in my category options. If you really want to read more about straddles just google it. =P
Dont worry i will share more of GTS soon.

3. Chiu on August 14th, 2007

It is interesting to look at this simple strategy. I randomly pick one recent date to do the backtest on GOOG. Picked 1 Aug 2007 closing price at 512 for GOOG, put in buy to buy 500C and 520P Sep option. Forward the date one day after another day, the trade lost money over the next few days.
Does it mean this strategy is more meant for Intraday to a maximum of 2 days holding ?
Where is the stop lost level for this strategy ?

4. akalawoo on August 14th, 2007

Hi Chiu,
Thank you for your comments as i believe more feedback will make the strategy better and will benefit to everybody. First thing is you cant use the GTS1 if google is at 512 cos you wont have a equal price for call and put. To qualify for GTS1 google price have to be 500 505 510 so on and so for. Also if you buy a 500 call and 520 put when google price at 510 you shouldnt be losing money even when google price still at the range of 500 to 520. The most is you lose the slippage money and time decay.
This strategy GTS1 is not meant for Intraday, is more for interday. That why i say dont buy the current month option.
I say normally will be profitable less than 2 days but sometime you have to wait abit longer especially when google going sideway at the moment if you look at a larger picture.
This strategy GTS1 dun have stop lost as you wont need it because the call and put should compliment each other and when you want to cut, you should just cut both leg.
Hope i explain it clearly to you. Lastly if you buy in 01/08, you should be able to make money on 08/08. =)

5. Chiu on August 15th, 2007

I did some back test that I would like to share. I picked two dates in Jul 2007 that have the GOOG price near the whole number and another date in Aug 2007 near the whole number. Here is the outcome. Choose the next month contract based on daily closing option price :
1) 2 Jul 2007 GOOG at 530.38
a) ITM Strangle of Aug 520 Call and 540 Put at $4870 debit. (second day already profitable)
Make $340 by 10 Jul 2007 at 7% return in 8 days.
b) OTM Strangle of 520 Put and 540 Call at $2860 debit.
Make $360 by 10 Jul 2007 at 12.5% return in 8 days.
2) 6 Jul 2007 GOOG at 539.4
a) ITM Strangle of Aug 550 Call and 530 Put at $4960 debit. (second day already profitable)
Make $440 by 17 Jul 2007 at 8.8% return in 11 days.
b) OTM Strangle of Aug 550 Call and 530 Put at $2970 debit
Make $440 by 17 Jul 2007 at 14.8% return in 11 days.
3) 6 Aug 2007 GOOG at 510.0
a) ITM Strangle of Sep 500 Call and 520 Put at $4780 debit. (second day negative at -$210)
Make $200 by 9 Aug 2007 at 4.2% return in 3 days.
b) OTM Strangle Sep 520 Call and 500 Put at $2700 debit
Make $210 by 9 Aug 2007 at 12.8% return in 11 days
But if did not take profit on 9 Aug, the position becomes negative, up to -$530 on 14 Aug 07.
From the above back test, it seems to be viable strategy. The strategy will likely to lose money in the following situations :
1) The IV drop with the price move than $10 in price.
2) The price did not move more than $10 in range trading, the option premium loses value due to theta.
Similar strategy should be able to play on volatile stock such as CME. Did a back test on CME on 6 Aug 2007 when it was at 605. It is profitable.

6. akalawoo on August 15th, 2007

Hey chiu,
Thanks for the backtesting haha =P. Seriously i found out this strategy when i was scalping google in one direction. I was having a hard time chasing it up and down, so i decided to buy a call and a put. Then i saw a trend in google which i can profit either both or just win one leg and lose abit on the other leg. Through this then i slowly realise that im using a strangle to trade Google.
And thanks for Jack and You, I can see that OTM and ITM dosent make any different. I can see that OTM is better because the debit is cheaper too haha…
Btw im did not use this GTS1 because i will take 1 leg when it gain its maximun gain then either cut lost on the other leg or sometime i may even gain on the other leg too. I can do it consistently due to my technical analysis which i use for scalping/day trade.
But for stablity i still find GTS1 the best as it really only little risk as compare to other methods.
Once again thanks for the contribution and i hope you will benefit from it too =)

7. Chiu on August 16th, 2007

Lawrence. I have the following questions :
1) Is it better to a narrower strangle like 500/510 when GOOG at 505 or 500/520 when GOOG at 510 from your experience ?
2) How many trades have you done on this strategies ? What is the success rate ?
3) Are you able to share your lost cases using this strategy ?
4) Yesterday I noted that the next month OTM strangle when GOOG at 505 for 500/510 is about $0.8 slippage between the bid and offer price. Which is better way for entry ?
a) Put in the mid price and hope it will be filled ? Could it be filled at mid price ?
b) Put in the bid price of the strangle and when the GOOG moves away to get filled.
5) From your experience what will be a good guideline on the exit ?

8. akalawoo on August 16th, 2007

i think OTM is better as i tried it out the first time yesterday. The slippage will be smaller also.
Seriously speaking i havent really use this strategies yet because im using my GTS2 which has a consistent basis of making profit. The success rate for GTS1 i guess is about 80%.
GTS2 is a combination of google behavior and scalping technics. =)
As i said before i didnt really use GTS1 yet so i dun have any loses for GTS1.
My only google failure is yesterday trade. A lost of 6k due to my own GREED and not the GTS. The GTS i use is GTS3 which is the risker among the all.
So overall my GTS system has a success rate of 90% . That is only applicable for me because it is created to be suited me in the first place.
Trading google still make my account grow even the lost of 6k.
Yesterday i buy 2 OTM 500/510 sept contract when google at 505 haha. The slippage is about 30 cent for call and put so add up around 80cent.
For me i just buy the market price as long as the slippage not very great like 20 - 30 cent is okay for a leg. Mid price will be a bit risky as it will not be balance… unless you know which direction will have a higher chance of success for your entry.
Exit strategy is really depend on yourself. Im happy to make 100 buck every day for 1 contract of call and put. So what is your daily target ??
What is your target for your trade ?? what is the loses that you set for your trade ??
My 2 contract sept call/put already make me 300 buck at the closing yesterday. If today(16/aug) tank again i will make more … =)
I hope i have answer your question =)

9. ddarius on August 16th, 2007

Hi,
Have been reading all the earlier posts and some parts seem pretty hard to digest. (eg. gamma scalp?? the IV drop??)
Anyway, just to clarify.
If GOOG is at 505 now.
I buy OTM 500P/510C (suggested by Jack).
Assumingly, this strangle is delta neutral.
Now, GOOG moves up to 511 the next day.
This is the profitable zone.
The Call makes more money than the Put is losing money.
Why is this so?
Is it because the Call is now ITM, and has intrinsic value?
Because if the delta stays the same, then the Call will be only making as much money as the Put is losing money. Then it will breakeven no matter where the price move.
So am I right to say that when the Call is ITM, its delta increases more than the Put’s delta??
Thanks.

10. akalawoo on August 16th, 2007

Hey darius,
Gamma scalp and IV drop are all the terminology of options strategy which can be pretty hard to absorb.
Why is when google move up till 511 is a profitable zone ??
This is because the call is already from OTM to ITM and the put is from OTM to deep OTM. This is significant because the delta will change, so do gamma and other Greek …
when the call is ITM and put is deep OTM, the delta of call should increases and the delta of put should decreases. I say should is because the option greek changes everytime.
Seriously im still learning on option strategy. Using Option as a tool to trade is different to using option as a strategy to trade. Im already know how to use option as a tool but as a strategy im still in an infant stage.
You can learn more about option by visiting jack forum at http://jwong139.proboards84.com

11. Chiu on August 17th, 2007

Lawrence,
I relook at the strategy and did a few more back test to take note of the characteristics of the strategy.
Let look at 10 Aug 2007 with GOOG closed at 515.75, do a Sep 500P/510C OTM Strangle at $3100 debit. Please take note that this position will have the following greeks :
- IV 25.5
- delta = 9.66
- gamma = 1.76
- vega = $137.7
- theta = -$42.2
On the next trading day 13/8 with GOOG closed at 515.50, almost unchanged, the position loses -$370. IV 24.4
On 14/8 with GOOG closed at 508.8, the position loses -$540. IV=23.2
On 15/8 with GOOG closed at 497.58, the position loses -$100, IV=25.6
So the position be affected a lot by the change in IV, every 1 point change in IV, will affect the P&L quite a fair bit.
By looking at the greeks, it is showing us that as well
- vega = $137.7
- theta = -$42.2
1) Every point drop in IV will cost the position $137.7
2) Every day of time decay will cost us $42.2.
So this might not have a single strategy of waiting for the GOOG to trade around whole number of mid point of the strike point. We will need to observe the IV. Help IV will help us to gain in vega which is high in this case.
Chiu

12. Victor on August 18th, 2007

May I know, how you all can get history of options price to do back test?
Where to get it?
Thanks.
Victor.

13. Chiu on August 20th, 2007

Victor,
It is difficult to get past option price for back test readily. Genarally there are two ways to do that, one is to pay for the past data. The other is just some subscribed software such as Optionetics.
Chiu

14. Victor on August 20th, 2007

Chiu,
How did you do it? Are u using optionetics?
Thanks.
Victor.

15. Chiu on August 26th, 2007

Victor,
Pardon for not answering this question directly.
Last Friday the IV for most stock has dropped significantly. IV for GOOG is around 20% which is near 1 year low (from http://www.ivolatility.com), so I will look to put on a GOOG strangle trade.
Chiu

16. Victor on August 26th, 2007

Chiu,
Yes I also aware about IV drop. My GS IV also drop significantly, is it because the market is going no where, because there is still no answer about the subprime morgage?

17. akalawoo on August 26th, 2007

IV drop is a good thing as the option price will be cheap. =) Market will be going through a tough time ahead this week and i expect the IV to go up again as uncertainty will kick in yet again with the upcoming news and earnings.
Personally i will buy a strangle on google again as it seem to going stronger and stronger haha but still dunno where it will go. 70% say up 30% down. Better to play safe and have a better sleep to just buy a strangle =)

18. Chiu on August 28th, 2007

Victor,
Generally IV drops with the broader market price up. A stock IV drops after the earning announcement.
VIX measures the fear factor in the market place. VIX increases with the broader market price down. IV generally goes up when VIX goes up.
In the recent event, the VIX increases to multiple year high on the sub-prime crisis. It reached a multi year high of Intraday 37.5 before dropping down to 20 last Friday (24 Aug). Similarly IV goes down with the drop in VIX and broader market retracement.
One other characteristics is the IV generally increase when the stock / index becomes less volatile, ie range trading. It is what happens to GOOG when the daily range becomes smaller.
In this Google Strangle strategy, we want the following things :
1) IV to increase as I say before the strategy is just too sensitive to vega. In facts, I will not advise to go for $100 profit as your potential loss could be a lot more. For a very good example, just take any trade from beginning of last week, it is difficult to be profitable with the IV dropping. It makes more sense to enter a trade when the IV is low and have good potential to move up.
2) Price to move, delta to increase.
Let come back to GOOG, recently it is less volatile, so the point 2 might not be there yet. So we want the point 1 on our side. As I feel the market will move, so it might be ok to put on trade now.
Chiu

19. Victor on August 29th, 2007

Akalawoo,
I saw you on pattern trader winning games thread, you are playing a very wide strangle on GOOG, 490 - 530 and 500-530.
So, the GTS1 can accept a very far OTM strangle, instead of near OTM?

20. akalawoo on August 29th, 2007

Yes you can use OTM. Actually ITM and OTM is the same. Please read the comment by Jack and you will know the different. Actually OTM is better as it is cheaper.

21. Chiu on August 29th, 2007

Lawrence,
I saw your posting on greeksman message board on what causes the strategy to lose money. In my opinion, there are three greeks elements :
1) Delta : The price movement, which is your initial focus.
2) vega : the increase in IV is good for you. For example, on Monday 27 Aug, the IV for GOOG is low around 21.5%,, last night on Tue 28 Aug, the IV has increased 2% to around 23.5%. Even if the price does not move you will make money. Of course, if the IV drops, like last week, the strangle will lose money.
3) Theta : Time decay that you understand.
Read my posting on 17 Aug on specific number. You could capture some price IV information for some days, then you will study it.
Chiu