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This approach to trading offers three compelling advantages: a reduced risk/return profile, limited market exposure, and extremely high returns on a percentage basis. In addition, the focus on price distortions and market anomalies makes for a direction-neutral strategy that doesn’t rely on the investor’s ability to “pick stocks.”
In point of fact, just a few days before these words were written—at the April 2008 expiration—the exchange-traded fund OIH opened at $200 with the $200 straddle trading for approximately $2.50. By 12:00 the stock had climbed to $208, and the straddle was worth more than $8.00—a 220% profit. Stated differently, every $10,000 invested grew to $32,000. This sort of behavior is the norm on expiration day when stocks move from one strike to another and options are very inexpensive. More important, an investor who purchased this straddle risked only a modest amount of steady time decay. A typical...
Almost invariably, simple short positions designed to benefit from implied volatility collapse perform best late in the day after the stock stabilizes near a strike price and most large positions have been unwound.