The Battle of Midway—The Straddle Is Profitable;Now What?

When the straddle we’ve bought has become profitable, and the 10-weeksleft point at which theta will start becoming nasty is still some time away,we have a decision to make, and it’s the usual one: fold ’em or hold ’em.Claim the profit, or try for more? I would dearly love to write down three easy rules for us to follow in order to make this decision, but I don’t happen to know them. There are clearly some principles worth adhering to, though.

First, perform two more historical studies. The first runs from now (whenever “now” is in our trade) to the date our straddle expires. The second runs from now through whatever date is 9 weeks from expiration. If both studies indicate that the market is historically apt to continue in our now-profitable direction, and if we aren’t already profitable to an above-average extent (as suggested by our original historical study of the strangle),let’s sit for a bit.

If short-term supply/demand factors appear to be favorable also, that’s a bonus, but not necessary to our decision.Our mission in this case is to retain or enhance profit in hand. Taking any action (and sitting still is an action) that is less than 3-to-1 in our favor from this point is just plain wrong.

Clearly, the probability of success from here (that is, increased profit) is not well-defined for every action we might take, but this isn’t an undesirable situation. If we can’t approximate our continuing advantage for any given action, we simply won’t take that action. If none of the possible set of actions offers us, even apparently, the degree of advantage we want, we’ll just take our profit, and find another good trade.Reasonable?

Or, maybe, not so fast. Just because our trade began as a straddle in no way implies that it must remain so for all its life. Suppose that our historical studies from this date are moderately favorable toward our trade, toward the direction the market is now moving, but nothing to rave about. Perhaps current supply/demand considerations are also somewhat in our favor, too.We do have an option here (er, so to speak).

We can consider converting the straddle to an option spread, biased in the market’s current direction.The mechanics of this conversion are a snap. Let’s say that the market we’re straddling has moved higher since we entered the trade. If we elect to convert the trade, we sell back the put option we originally bought, at a loss to be sure, but this sale still shifts capital back into our pocket.

We’ll complete the conversion by writing an OOM call that expires when or before our original long call does. If, in our example trade, JOX had moved to 102.00 by July 15, the strangle would have been trading at 1280–1350, perhaps higher, and the September orange juice (JOU) 105 call would have been priced at something like 240–270 points.

Not a rich reward for writing the JOU 105 call, I grant you, but if we have reason to consider that orange juice is even a reasonable favorite to move higher between now and the expiration of the September options, this might be worth our examination.Selling back our JOX 90 put probably nets $50 to $60 at this point, nothing really, and writing the JOU 105 call for 230 points net would add about another $200 to our side of the ledger, totaling perhaps $400 per original straddle after all our trading costs.

This amount may be numerically small in the world of trading, but dismissing these dollars out of hand would be plain silly. They happen to represent about 34% of our original per-straddle capital. No matter which way we decide, to attempt an enhancement or simply to accept the profit, on occasion we’ll be wrong. When we accept our trading gain, sometimes the market will keep on moving, and we’ll be tempted to kick ourselves for throwing away a chance at an exceptional profit.

Resist the temptation! If a trading decision is sound, if it represents the best or nearly the best we can do at a given time and with a given set of information about the market we’re trading, let it go. Traders wander into the “woulda, shoulda, coulda” game far too often, and where’s the benefit? Second-guess yourself for the next X months or years? What an incredibly unprofitable idea.

If we elect to try to enhance the profitability of the trade by converting the straddle to a directional spread (bullish, in our example), and the market begins to move against our newly adjusted position, the same reasoning should apply, with one important exception.

If the market begins to move in such a fashion that our existing profit is at risk of vanishing, we exit, period, stop, end, no discussion, and as fast as we can. Sell back the long side and repurchase the shorter-term September options we’ve written, or, if historical studies and current market conditions warrant, try to hold the short side of the spread until expiration.