A Straddle Strangle Swap on Berkshire

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.

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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)

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.