Stocks and Commodities Magazine

Part 3 of 3...Trading Success Using Option Strangles

If strangle traders can make money regardless of market direction, doesn’t it provide the best odds of success? (Part 3 of 3)


In the previous two columns we addressed the pros and cons of trading option strangles. This month, we are going to focus on the strategy of placing futures strangles. Futures strangles differ dramatically from option strangles in that the reference to strangle applies to the trade entry orders rather than the trade itself. To illustrate, an option strangle is a strategy in which a trader holds open, and opposite, positions in calls and puts with the same underlying asset; those trading futures strangles are placing opposite orders to enter a futures contract with the intention of being filled on only one of them. This makes sense because a trader cannot be long and short the same instrument simultaneously, but he can be positioned to attempt to profit from either a rally or a decline should one of them materialize.

Specifically, a futures strangle involves the placement of a buy stop order above the current market price, and a sell stop order below. If you are not familiar with a stop order, it is simply one in which a trader will buy a futures contract if the market rallies to the stated price, or sell a futures contract if it falls to the stated price. Traders typically place their stop orders at, or beyond, support and resistance levels in hopes that a break out of the range will elect one of his stop orders. In other words, the trader is anticipating a big move in one direction or the other, and believes he can profit from the momentum of a break out.

On paper, futures strangles appear to be a promising strategy; after all, a range bound market will eventually break out of the pattern in one direction or the other. In reality, trading futures strangles is a very difficult way to make money because what is inevitable in the long-run, can be chaotic in the short-run. For instance, markets often experience “false break outs”; in such a scenario the futures price will move above or below the current consolidation pattern, but prices then quickly reverse at precisely the most inopportune time for a break out trader. In theory, the momentum of exceeding support or resistance levels should provide an extension of the move, but in reality we often see the buying or selling dry up. It only takes a few of these mishaps to frustrate a trader and cause significant financial damage to a speculative account.

 

More about option strangle trading (Part 3 of 3) in the March 2014 issue of Stocks & Commodities Magazine... 

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