This is a guts position. If a guts position is set up at the same time rather than legged into as this trade was the premium received will be greater than the distance between the two strikes and as long as the underlying expires within these two strikes a profit will arise. Crucially a guts position has a zero delta and so does not move around as the underlying moves.
As mentioned we legged into our position and so did not have a zero delta but it did have the effect of more than halving our straddles delta from 77 to 33. This effectively cut our risk by more than half. Over the next 48 hours we did indeed see oil fall back below the $60 mark trading as low as 5880. At this point we were now inside our guts and close to using up all of the credit received from the $60 puts ($1.26).
However because we had now traded five dollars lower than the $63 high the straddle had substantially come back onside. At this point we started to look for our exit from the trade as the initial idea of oil trading within a $10 range was now defunct. The team saw a bounce up to the $60 level and then further retrace lower. We decided to monitor oil and on a bounce, exit our $60 puts. They were exited for a cost of $.25 netting us a $4000 profit. OiI did then indeed fall back from the $60 or level and we exited our straddle for a $5000 loss less the $4000 profit from the $60 puts meant that we exited the entire trade for only a
This is trade and subsequent risk management show how knowing the right tools to use and when to use them is invaluable in options trading. To a less experienced trader the purchase of calls may have seemed the most logical way to hedge risk but in this case as we had a retrace in oil they would have realized a total loss on the calls. Furthermore had oil not gone any higher and just pinned at $63 then the purchase of calls would’ve also lost a huge amount of money as the volatility would have collapsed and more than half the value of the calls would have been lost. By selling puts we exploited the higher volatility and stacked the odds in our favor as it was much more probable volatility would fall from 75% than continue to climb.