The Best Options for Neutral Trading
Most investors try to capitalize on value fluctuations in a stock's price. They profit when a stock goes up or, in the case of short selling, cash in when a stock declines. Neutral trading, however, is distinct in that the performance of the investment is independent of an increase or decrease in the stock's price. Rather, it hinges on volatility, the degree to which the price fluctuates up or down.
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The Long Straddle
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This trading method, also known as the "option straddle," is bullish on volatility, meaning that it is most lucrative when a particular position is highly volatile. Traders simultaneously purchase a put and call with a set expiration date (or sell point.) This option can be represented by a hypothetical V-curve, where the stock price at expiration (after holding for the long term) is expected to be high.
The Short Condor
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This neutral trading method has limited profit potential but also limited risk. It is an attractive option for investors who expect a stock to shift in price in either direction quickly. The most profit that they can extract from this strategy is a function of the credit received upon initially making the investment. The short condor consists of purchasing a strike call, selling at a lower point, buying at a higher point and then selling at a still higher point.
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The Short Straddle
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The short straddle differs from the previous two methods in that you employ it with the anticipation of a low degree of volatility. In other words, it is a neutral option that seeks to maximize profit from a stock expected to undergo minimal price shift. To pursue this trading strategy, one must at the same time sell a put and call that share the same underlying striking price and stock price. One drawback of the short straddle is the theoretical potential for unlimited loss, in the event that volatility becomes increasingly high.
Ratio Spreads
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Ratio spreads are similar to the short straddle in that they represent a neutral trading strategy that seeks to "short" volatility, or profit from the lack of volatility of a given stock. They are ideal for situations in which you predict the value of a stock will hold steady over the short term. Ratio spreads involve buying puts at a higher strike price, holding them and selling a larger number of puts at a lower strike price.
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References
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