Visually construct and analyze options strategies

Covered Straddle

Options Strategy - Covered Straddle

Description

A Covered Straddle is the combination of two other "bullish" strategies - Covered Call Write plus Writing Puts. Both options share the same expiration date as well as the same striking price. Note: Covered Combinations differ in that the two options have different striking prices.

When to use

An excellent alternative for stock investors. The key is that the stock investor purchases only one-half the amount of stock that he or she would normally be willing to purchase. For example, buying 100 shares of XYZ and writing the two options is a lower risk investment that the outright purchase of 200 shares of XYZ. At expiration, the investor will have either a $937.5 profit and no position in XYZ stock or own 200 shares of XYZ for an average price of $55.31!

Risk/Reward Characteristics

Profit potential is limited, but greater than a Covered Write. Maximum profit equals Straddle premium plus strike price minus initial stock price. Losses are unlimited because the investor could end up with a long stock position twice the initial size. Because of this fact, the investor must carefully consider the initial size of the spread!

Break-even Point: (Stock Price + Strike Price - Straddle premium)/2

Time Decay: Positive. Over time, the time value portion of both options erodes (i.e., decays). At expiration, only one of the two can be in-the-money and equal to its intrinsic value. The other will expire worthless!

Volatility: Because this strategy contains several written options (Call and Put), a change in volatility can have a large impact on this spread. If volatility increases, both options increase in price. Given a decrease, both written options decrease in price.

Assignment Risk: With two written options, the investor must watch XYZ for possible assignment on whichever option is then currently in-the-money. Of the two possible assignments, the Put is the one that should concern the investors the most. First, the investor's stock position doubles with the notice of assignment. Secondly, if XYZ has declined enough to warrant the Put exercise, maybe the investor should re-examine his or her original bullish opinion.

Options Strategies :: Bullish Strategies :: Covered Straddle Back to top