A Straddle Strangle Swap on Berkshire

by OptionPundit on February 9, 2010

This post will explain what’s a Straddle Strangle Swaps option trading strategy? And also share a trade idea on how to use this strategy on Berkshire Hathaway (BRK.B) to make some money while learning it as well.

A Straddle Strangle Swaps (SSS) is the sale of a front-month Straddle and the purchase of a back-month Strangle. From the pictorial perspective, it looks like a simple Calendar Spread.

(For beginners who are wondering what is a Straddle and Strangle- A straddle is long 1 call and long 1 put at the same strike price and expiration and on the same stock. For example, long 1 IBM Mar 120 call and long 1 IBM Mar 120 put ; and a Strangle is long 1 call at a higher strike and long 1 put at a lower strike in the same expiration and on the same stock. For example, long 1 IBM Mar 125 call and long 1 IBM Mar 105 put)

Straddle Strangle Swap (SSS) is a Market-neutral, defined-risk position that profits from positive time decay (theta) as well as collecting credits from rolling short options forward. Most of the time it is a Theta Positive, Vega positive and Delta neutral. Albeit, depending upon IV skew it can be Vega negative; and as underlying moves higher/lower than the short strike, trade can convert into a directional trade thus delta positive and delta negative.

[OPNewsletter has outperformed the broader market. Pls read customer reviews or If you would like to sign-up for OPNewsletter directly, pls click here to sign-up for the wait-list (as the subscription is by invitation only)].

The key difference between a Calendar spread and Straddle Strangle Swaps (SSS) is that of flexibility of converting SSS into a Double diagonal, which can then also be converted into an Iron Condor. For instance- Straddle Strangle Swaps/Double diagonal will benefit as IV rises, and then by converting it into Iron Condor, one can benefit via selling high IV.

The key strategy is to get as much credit as possible from the rolls. The way to maximize that amount is to hold on to the short options to let them decay as much as possible. But the longer you hold the more short Gamma will be and thus more sensitive to changes in the underlying price. That’s why it makes sense to look to buy the short front-month options back and sell out the same strike options in the next month, starting at about 2wks prior to expiration. Between 2weeks away and 4 days away, you should look to roll the options to maximize credit.

Remember- “Buy Low, Sell High”- When the options you want to sell have a higher implied volatility than the options you need to buy, you will receive more credit. Roll It! If a market moving/ or stock moving news is coming out (e.g. earnings announcement, FOMC announcement) that might increase volatility, it is usually a good idea to close the trade. Another watch out is the drop in IV; Vega positive trade will lose money as soon as IV starts to drop).

Here are the steps for the BRK/B Trade:

  • Buy a Jun’10 76/72 ‘strangle’ (Buy a 76 Call (leg 1) and buy a 72 Put (leg 4); @Debit $8.15)
  • Sell a Mar’10 74 ‘straddle’; @Credit 6.80 (Sell a 74 Call (leg 2) and sell a 74 Put (leg 3)

Starddle Strangle Swap

Based on the margins, the trade will cost – $8.15-$6.80+$2.00 (difference in strikes)= $3.35.  This trade will not lose more than the $3.35. The maximum profit will occur if BRK.B will remain at $74 at Mar’10 expiration and if IV profile remains the same. At that point, gains are expected to be $5.00, over 100% yield.

Make sure that you have already stress tested it and have a risk management plan in place before becoming excited with the “potential”.

Disclaimer- As of this writing, I have not invested in this trade. I might change my opinion/ underlying any time. Pls do your due diligence before investing any money into the trade ideas that are listed on this website.

Share the knowledge.

{ 9 comments… read them below or add one }

1 OptionPundit February 9, 2010 at 10:46 am

I opened the trade-
- Sold the March 74 straddle for $6.65
- Bought June 76/72 strangle for $8.20

Total investment= $3.55

2 Kim February 9, 2010 at 3:38 pm

OP,

This is basically very similar to double diagonal, only with short strikes the same. My broker (IB) requires double margin (on every side) for those trades. Does your broker requires margin on one side only?

3 OptionPundit February 9, 2010 at 7:41 pm

Kim,

You are correct. This is similar to Double Diagonal. In Straddle Strangle Swap, the short strikes are the same while in case of Double Diagonal those are different (strangle vs a straddle).

Many brokers requires only 1 side margins e.g. ThinkOrSwim. Check with IB if they have a criteria to waive this requirement.

Profitable Trading, OP

4 Steve Becuti February 9, 2010 at 8:12 pm

I opened the trade with some difficulty.
strangle = $8.10 debit
straddle = $6.40 credit
Total = $3.70 debit

5 Kim February 10, 2010 at 11:00 am

I tried to find out with IB why they have double requirements for DD, they provided the following explanation (it doesn’t make any sense to me, like many things that IB do, but their commissions are still hard to beat, and this is the main reason I stay with them):

The different time-to-expiration will create additional risk of the option strategy and additional price uncertainty of the underlying therefore if you trade option spreads in different expiration month, that will not be considered as Iron Condor and the risk of the strategy will need to be evaluated differently base on both option spreads since the risks of the option legs can not offset each other at one time point. Please feel free to research this topic on other resources.

The risk will not be exact the same. The potential for P&L is limited at the same time point in Iron Condor strategy, that is why we only require the margin requirement on one of the spreads (call or put spread) that make up the Iron Condor. However in the example your provided, you are obligated to deliver shares in the case that one of your short call option is deep in-the-money on DEC exp. Due to OCC’s assignment processing sequence and the fact that a long option may have remaining time value, IB cannot automatically provide an exercise notice to OCC for any long option spread against the assigned short option as a means of offsetting the ensuing delivery obligation UNLESS they are expired at the same time point. The American style equity option exercise prior to expiration should be requested manually by the user and that creates additional uncertainty.

Therefore in this case, IB would require margin on both spread, CALL diagonal spread and PUT diagonal spread, respectively.

6 OptionPundit February 10, 2010 at 12:11 pm

It seems they won’t negotiate. How about this Kim- Review the Return on investment in both and choose the one that make more sense. I tend to think that TOS will provide better yield as margin requirement for double diagonal/ straddle strangle swap will be half.

Separately, You may send TOS an e-mail with your current IB commission structure and use OptionPundit as referrer, they might offer you better than published rates. But in the meanwhile, pls decide if you want to open this trade with IB :)

7 OptionPundit February 16, 2010 at 10:07 am

As of this writing (10am US EST, Feb 16/10), The trade is up >+10%.

8 Christopher Clatts February 24, 2010 at 9:23 am

Are you making any adjustments to this trade due to the recent run-up in the stock price?

9 OptionPundit February 24, 2010 at 1:59 pm

If you didn’t book profits @ 10% and still have it opened, then not yet. It is just near the upper break-even and i would rather wait for a few days.

Leave a Comment