Hedging An Inverted Straddle Option Trade

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Straddle: In this video update, we're going to cover all the trades that we made for Thursday, October 22nd. Sorry for the later video, we are just out with family at a local high school volleyball game. It was the championship for the district. My brother-in-law is one of the coaches. They won, which is great.

Sorry for the late video getting back to you guys. We had two earnings trades today that we got into, nothing closed, nothing hedged. We got into an earnings trade in Amazon and then earnings trade in P, which is for Pandora.

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In Pandora, we'll talk about this one first. We did the straddle in Pandora, and applied volatility very, very high, again went with the aggressive type trade, playing the odds, the 19 calls and the 19 puts took in a nice big credit of $219.

Unfortunately, Amazon, even though implied volatility was up in the 94th percentile and option pricing was really good, implied volatility now should be a good drop tomorrow but the stock price is down much further than expected. The market had priced in about a $2 move, which would put it right about $17 or so on the far end.

Right now looks like it's trading about 15 and a quarter, 15 and 30 cents or so. Moving down further than expected.

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Again, our position was at the 19 strikes, so here's where we are. We were slightly bearish until we had 19 strikes. Now the stock is trading all the way down here around 15 1/2-15 strikes. Remember, our adjustment strategy, and if you haven't already gone through the earnings trading guide section, please do that tonight or tomorrow.

This a couple of times as we get through this earning season, but I'm finding that the same questions are coming up over and over and over again, and we cover this in detail in our earnings trading section and through our earnings trading guide.

What we want to do here is we do not want to touch the side of the market that the market has moved against, or the side of the position of the markets moved again. That means we are not touching our put side. We're going to leave our put side on.

Instead what we're going to do is we're going to roll down our call side from 19 to something closer to where the stock is trading. Again, at this point, we're not trying to save the trade and make money. We're trying to eliminate some of the loss and give ourselves an opportunity to possibly keep this trade on for another month.

The basic strategy here is we're going to roll down the 19 calls. Those are going to be practically worthless tomorrow. We're going to sell something closer and go a little bit inverted. At the same time, we're going to roll this entire strategy out from the weeklies, out to the monthly contracts, so the next monthly contracts.

Those are going to be the November options. We're going to take the entire position, and we're going to roll it out to the November contracts, which have 29 days. Again, what we're trying to do here is just get a little bit more credit overall to widen our break even point, plus we want to get a little bit more time to be right because this thing can come back in and implied volatility is going to drop.

We just want a little bit more time for this thing to rebound, maybe regroup a little bit. We'll be moving our 19 puts out to November immediately, and then we'll be rolling down and moving the call side out to November at the same time. All in one full swoop. Here's what the position looks like right now.

Again, stock's trading right about here. Our main objective is to make money right at 19. That's not going to happen. The stock moved much, much lower. What we're doing is we're moving our 19 calls down to somewhere around where the stock is going to be trading.

For the purposes of this video, just to show you guys an example, what that payoff diagram would look like if you were to enter the order to roll down just the 19 puts, I'm sorry, the 19 calls to the 15 strike is that it would now make you inverted and you basically get this very wide strangle-type looking payoff diagram.

The idea here is, again, now that the stock is trading inside of this range we just want to see either a steady move in the stock here of just staying there, or we want the stock to move higher and kind of stay in this range and we could get a chance to recoup some of the money that we're going to lose on paper.

That's, again, the strategy going into tomorrow for Pandora. As far Amazon is concerned, let me just go back here to Amazon. We did a very wide iron condor of the 620-625 calls, 500, 495 puts, doing a nice credit of a $1.67. Again, that credit moves our break even point out $1.67 on each end.

Amazon had high implied volatility, and we would've loved to do the strangle, but with a $500 stock, it's just really hard to carry the margin for that type of position. After hours Amazon is trading higher, but it's trading around 615-618, so just on the edge of where our position is right now.

Again, that credit that we took in moved our break even point another $1.67 past the 620 strike which is our short strike on the call side. We have a little bit of wiggle room here, so we'll have to see what happens tomorrow when Amazon opens up, but right now where it's trading after hours, it traded higher than this, and it's come back down.

We might have a good opportunity here to close out this position for maybe a small profit, a scratch, something like that tomorrow morning. We'll focus mostly of our attention on Pandora, but obviously, want to get this position off as well. As always, if you guys have any comments or questions, please let me know.

Until next time, happy trading.

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. In 2018, Option Alpha hit the Inc. 500 list at #215 as one of the fastest growing private companies in the US. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and three children.