Guts is a simple adjustment to the Strangle, but this adjustment makes it more
expensive. Instead of buying out-of-the-money options, we buy in-the-money
calls and puts, which creates a higher cost basis.
with the Strangle, the risk we run with a Guts is that the break evens can be
pushed further apart than with a Straddle.
even contemplate a Guts, the Straddle criteria must have been satisfied first.
We buy higher strike puts and lower strike calls with the same expiration date
so that we can profit from the stock soaring up or plummeting down. As with the
Strangle, each leg of the trade has limited downside (i.e., the call or put
premium) but uncapped upside.
the same challenges apply regarding Bid/Ask Spreads and the psychology of the
actual trade. Remember that time decay hurts long options positions because
options are like wasting assets. The closer we get to expiration, the less time
value there is in the option.
the Straddle rules but then make an adjustment for the Guts:
Instead of trading the ATM calls and puts, choose the next strike higher for
the put and the next strike lower for the call.
Now compare the break even scenarios for the Guts to the Straddle. Typically
the Guts break evens will be slightly wider. The Guts isnít very attractive
when compared to the Strangle, but you can always compare the two with the
Straddle, using the Analyzer.
You expect increased volatility in either direction.
is a more expensive strategy than a long Strangle. If you use it, you are doing
a neutral trade, when implied volatility is low, for income. You are expecting
the stock to either drop or rise significantly.
is trading at $25.37 on May 12, 2011.
August 2011 $22.50 strike call for $4.20.
August 2011 $27.50 strike put for $3.80.
benefit is that it enables you to profit from the volatility of a stock moving
in either direction with unlimited profit if the stock moves and limited risk.
risk is the net debit of the bought puts and calls minus the difference between
the strikes. The reward is unlimited.
debt paid minus difference between strikes.
even up: higher strike plus (net debit minus difference between strikes)
even down: lower strike minus (net debit minus difference between strikes)
for high volatility.
Of Time Decay
Time decay accelerates the fastest in the last month, so never keep the last
you have one month left until expiration, sell the position.
you have a profitable leg, you can exit and hope the stock retraces to the unprofitable
side at a later date. Sell the calls and take the profit. Although the puts
will have little value, you can hope that if the stock retraces it will
increase the value of the puts, which you can then sell.
the position. However, it is recommended to close one month before expiration.