Taking advantage of Time Decay in Options.

Krishna has this point to make:
“Why one should not write stardles or strangles to take advantage of time decay.

I have seen that it normally decays and can fetch a decent money if written in the beginning of series.
Is really risk is so high that retail traders should never go for it ??

Normally retail traders keep burning their hands through buying options as it gives a fake feeling of limited loss.Truth is very few retail traders make money in buying options while on the other hands options writers take good advantage of time decay through writing.

Please note that I am not talking about naked CALL or PUT writing but starddle or strangle seem reasonably good tool to make money.

I have studied on above matter through paper trading for almost one year and in my knowledge area results are normally okay”

My Notes:
A straddle is a combined unit of call and put of the same strike price. buying a straddle refers to the purchase of same strike call and put. Selling a straddle refers to the sale of same strike call and put.

The Straddle buyer and seller take opposite sides of the same transaction. Therefore, only one of them makes money. Which one? Let us take August series:
5400 Call: Rs 105
5400 Put: Rs 91

If we wish to sell a straddle, we receive Rs 196. Our breakeven is 5596 and 5204. Suppose a correction takes the Nifty down to 5200 in the next 10 days, say around August 7. What should the seller do? There is a chance that the Nifty may rally back to 5400 by the end of the series, i.e. by August 26. Should he wait?  Suppose the correction deepens and the Nifty closes at 5000 by the end of August. Then, the writer loses almost 200 points.

The problem with writing straddles is the confusion on the follow up action required, if market suddenly moves in one direction much before options expiry.

If you were a straddle buyer, and the Nifty fell to 5200, you could close out your straddle for maybe 240, thus making 40 points on an investment of 196. Or, you could sell an at the money put of 5200 strike for maybe 50 and also sell the 5400 call for 20, thus having a put spread 5400 to 5200 for a cost of 126 and potential gain of 74 points. Or you could simply sell the 5400 call for 20 if you were now looking for a deep correction. With a long straddle, there are many opportunities for adjustments.

The difference is risk. Short straddles have unlimited risk. Now, the risk can be managed, but once in a while it becomes unmanageable – browse the web on Long term capital management, Victor Niederhoffer, for just two of the big blowups selling options.

Buying a straddle limits your risk. If option premiums are high, you have a choice, do not buy options at all.