When are trades well priced, when are they expensive/cheap?

[Hannes Kury]

Kim,

You often say things like "...they are expensive/cheap...", "..if the price is good...", etc. I do not know how to assess if an RIC/straddle/strangle is expensive or cheap. Please give me some pointers so I can educate myself about this.

Thanks

Hannes

[Kim]

Kim,

You often say things like "...they are expensive/cheap...", "..if the price is good...", etc. I do not know how to assess if an RIC/straddle/strangle is expensive or cheap. Please give me some pointers so I can educate myself about this.

Thanks

Hannes

This question requires a separate topic which I will post shortly. In general we comparing the current implied move to historical moves. More later..

[Kim]

Just posted a topic about entry prices.

[mosaic]

Hi Kim,

That was a very informative post. I have some follow up questions to ensure that I completely understand when to identify a cheap trade in different option strategies. Can you provide examples on how to calculate the implied moves with a RIC and a strangle?

Thank you,

[Kim]

The implied move can be calculated with a straddle only. But if you think that options in general are cheap based on the implied move calculated by the straddle price, it would be reasonable to assume that strangles and RICs are cheap too.

[Marco]

well if the stock is between 2 strikes the strangles should still be a good measure of the implied move. Say you have the stock at 36.5 and the 36/37 Strangle trades at 1.00 then the implied move/break even for the STR would be 4.1% (1$ premium + 0.50$ the stock has to move before either option is in the money = 1.5/36.5 = 4.1%. Alternatively you could add up the premium for the 36 and 37 Straddle and divide it by 2 for an approximation of the "36.5 straddle" and divide that by spot to get to an implied move - should get you to about the same value as the strangle.

[Kim]

well if the stock is between 2 strikes the strangles should still be a good measure of the implied move. Say you have the stock at 36.5 and the 36/37 Strangle trades at 1.00 then the implied move/break even for the STR would be 4.1% (1$ premium + 0.50$ the stock has to move before either option is in the money = 1.5/36.5 = 4.1%. Alternatively you could add up the premium for the 36 and 37 Straddle and divide it by 2 for an approximation of the "36.5 straddle" and divide that by spot to get to an implied move - should get you to about the same value as the strangle.

Right, but straddle still give you a better measure. Look at ARUN for example, currently around 16.35. The 16 straddle is priced at 1.80, 17 straddle at 1.85, and 16/17 strangle at 1.35. Which one gives you better measure of the implied move? I think the 16 straddle. The strangle will slightly underestimate the move.

[Marco]

Right, but straddle still give you a better measure. Look at ARUN for example, currently around 16.35. The 16 straddle is priced at 1.80, 17 straddle at 1.85, and 16/17 strangle at 1.35. Which one gives you better measure of the implied move? I think the 16 straddle. The strangle will slightly underestimate the move.

at 16.35 I probably would also go with the 16 Straddle, but even with the avg. straddle premium (1.80+1.85)/2 = 1.825 or Strangle plus 0.50 =1.85 you get to very similar numbers

Implied move is in between 11% and 11.3% depending what method you use - not a difference that would make you do the trade or stop you from doing it.

If the stock sits exactly between the strikes I think avg. straddle premium or the strangle b/e give you a better number than either the in the money or out of the money straddle.

[Kim]

Agreed.