The options market in Singapore has seen a lot of volatility with the increasing exposure to the derivatives industry.
With the growing competition from other financial centres, Singapore is looking to develop its market further.
There are two practical options trading strategies: straddle and no transaction strategy (NTS). An investor would generally use one or both of these depending on his investment objective.
Straddle vs No Transaction Strategy
The straddle option trading strategy is frequently used by aggressive investors who seek significant returns via large price swings.
A ‘strangle’ would be more appropriate for investors seeking moderate returns, while a ‘spread’ would better suit investors looking for low-risk investments.
Options trading have inherent risks which may cause substantial losses even when the trade is correctly executed.
When to use the Straddle Option Trading Strategy
For investors who are pessimistic about the market, it is advisable to adopt a strangle or another form of options trading strategy where the risk involved is not very high.
Investors may choose to employ this strategy if they expect significant fluctuations in prices.
When hired, an investor would have already expected significant volatility on prices just before the expiry date or at least within the specific time frame.
On the other hand, the no transaction strategy is used by investors looking for moderate returns with minor risks involved.
Under this scenario, an ‘at-the-money’ options trade is conducted. The no transaction strategy works best when there are minimal fluctuations in prices between contract inception and expiration dates.
How to use the No Transaction Strategy
The no transaction strategy can be used in a variety of ways. For example, an investor holding on to his long position would set up the option trade at the money and sell off the ‘call’ side.
He would then hold on to his shares and wait for their prices to increase before he exercises them and sells them off at market price.
When ‘put options’ are written and held without exercising them, this strategy would discourage investors from attempting naked short sales, limiting profit potential.
It may also help limit losses when prices of related stocks fall by more than anticipated, resulting in an exercise of both put and call options.
This could protect an investor against potentially significant losses that might result from such a scenario.
What is a Straddle Option Trading Strategy?
Straddle options trading works well in volatile markets when prices experience significant movements after their inception.
An investor may choose to employ this strategy if he believes that prices will swing significantly in either direction before the option contract expires.
Under this scenario, the investor will simultaneously buy a ‘call’ and a ‘put’ option to benefit from potentially large price swings upwards or downwards.
An investor would have chosen put options when he expects downward price movements while choosing call options to predict upward trends in prices. The use of both puts and calls allow investors to profit from either direction that prices swing in.
When to Use Straddle Option Trading Strategy?
Under this strategy, an investor may choose to write off his position before the expiration date by buying back the options he initially purchased before writing them off, even if their prices are lower than what they were when originally written.
This allows him to stop any further losses should it turn out that his initial prediction was incorrect.
How to Use Straddle Option Trading Strategy?
Investors employing this strategy would write off the options that they feel have a lesser chance of being in the money at the expiration date.
This allows them to limit their losses when they do not expect prices to move substantially in either direction and prevent themselves from further loss before the expiration date.
When using the straddle option trading strategy, knowing where prices are about strike prices is necessary.
If the cost of the underlying security is below the put strike price, then write-off or closing out his position before the expiration date would not help an investor avoid any further losses.
This is because there is no point in buying back options that will expire out-of-the-money.
Straddle options trading can lead to significant profit potential if employed correctly by investors who are knowledgeable about the movements of their investments and have sufficient capital for this trading strategy.
Conclusion
Investors can employ the no transaction strategy, which allows them greater flexibility when making trading decisions with their options.
The straddle option trading is used by more experienced investors willing to take on higher risk in exchange for potentially high returns.
Investors must recognize how the contract expiry date impacts the potential for profits and losses, especially when using the straddle strategy, to make informed investment decisions.
Follow Saxo for more options trading advice.
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