Last update: August 2021

When does a long straddle become tempting? I have a simple answer that is taking place in the market right now. But first, a brief review is in order.

Buying a straddle consists of purchasing an ATM call and ATM put. It’s a bi-directional, long volatility play that profits if the underlying moves more than expected and/or if implied volatility lifts.

Generally, I’m not a fan of the trade because it is difficult to make money with. Most of the time the market moves less than expected. The straddle wins if options were priced too cheap. And, well, most of the time they’re too expensive. But here’s a back of the envelope method to figure out if the strategy is tempting. Compare the straddle cost to the Average True Range (ATR).

Consider, for instance, the cost of the SPY 21 Dec $265 straddle which expires next Friday. That means it has six trading sessions left. How much movement do you think we’ll see between now and then? Wouldn’t the ATR – which is how much the market has been moving on a daily basis – give you an idea of what’s possible over the next six days? Sure it would.

The ATR for SPY is about $5. So over six sessions do you think it’s possible we could rise or fall 2 or 3 ATRs? If so, does that mean you would be willing to pay $10 to $15 for a one-week straddle in this market?

What if I told you the Dec $265 straddle was only trading for $6.90? That’s only slightly over 1 ATR, but you’re getting six trading sessions worth of exposure. Sounds cheap, doesn’t it?

At $6.90, that means the expiration breakevens or price levels we would need to be above/below if you hold to expiration are $271.90 and $258.10. Here they are highlighted on the SPY price chart:

Now, bear in mind that these are the expiration breakevens. If we approach either line in the next few trading sessions, then you’ll be well into a profit. It seems like a decent bet.

To be clear, when I can buy a six trading session straddle for a little over the price of one session’s typical range, it seems like a low-risk bet.

Lest you think this is free money, let me explain why it might not work. The current ATR is skewed very high. The last 14 days have seen monster volatility. By pricing a one-week straddle for only $6.90, the collective wisdom of the market is saying that volatility will subside over the week ahead. And it probably will. Aside from the fact that volatility is mean-reverting and big moves are followed by small ones, we also have seasonal winds to consider. In case you haven’t checked the calendar, it’s almost Christmas! If there were ever a time for the craziness to abate and a lull to settle upon the Street, it’s now. Or more specifically the next ten days.

So it’s entirely possible that the seemingly cheap straddle ends up expensive.

That’s the rub with trying to discover when the long straddle play is tempting. If they’re trading cheap, there’s probably a reason. That said, I do think long straddles are a less bad bet here than they usually are.

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