FAS straddle trade fails

As it turns out, the credit I got last week for a short straddle in FAS at the 10 strike for $3.05 was not a bargain after all.

Readers will recall my logic in selling high volatility (250%), my misgivings with being naked (buying back month strangle against short straddle) and my plan to roll the straddle from FEB to match up with my long strikes in MAR.

Well, FEB expiry has come and gone and what looked like a promising trade has blown up. Well, kinda blown up, because I defined my risk to a maximum loss of $2.50 ($250 per contract). There was an opportunity early last week to roll my short 10 put into MAR for about $0.60. That trade would limit my risk to $1.90 and would lose if FAS settled below $9.40. Looking at the landscape at the time, I decided not to roll and hold on to this trade. Why? Because I don’t like it anymore, that’s why. I didn’t want to be short the 7.5/10 put spread in MAR. That spread normally has positive time decay, but with my long hedge in-the-money, it actually has negative theta.

When you don’t like a trade, I find it better to plan an exit instead of trying to make it look prettier in hopes it will become transformed and you will suddenly like it again. With that in mind, I considered three viable strategies this weekend.

First, let’s recap my position on Monday morning. I am assigned the FAS 10 put and now own the stock (100 shares) at a price of $10 a share. My short 10 call in FAS expired worthless. My long strangle in MAR includes a 7.5 put and a 10 call. My cost of putting on the trade is $0.00 (excluding commissions and the cost of typing on my fingers). After I got assigned on Monday, and I of course was hoping something got missed and I would be left alone, I owned the following position:

Long 100 shares FAS (cost basis $10 a share)
Long MAR 7.5 put in FAS
Long MAR 10 call in FAS

Now back to my possible exits.

1. Sell stock and sell straddle.

2. Keep stock and sell straddle.

3. Sell stock and keep straddle.

When I purchased the MAR options, I did so to limit my downside risk to $2.50 and my upside risk to zero. Based on the principle of not widening my risk on a trade I don’t like anymore, I excluded choice #3. The reason being that I would book the $5.00 loss or so on the stock (FAS trading around $5) and I would risk the $3.05 I initially paid for the straddle if FAS settled between 7.5 and 10 by MAR expiry.

That leaves me with taking the trade completely off the table (choice 1), and with selling my straddle and keeping the stock as long as it’s new cost basis does not exceed a $2.50 loss.

Part of me wants to just sell stock and sell the straddle and leave this bad trade behind, but another part of me wants to at least give it a chance of redeeming itself somewhat. I decided to give the trade one last chance, so I chose option number 2.

I sold my straddle on Monday for $3.40. That creates a cost basis for my 100 shares of $6.60. Remember with this fancy footwork, let’s not lose sight of our commitment to not extend the risk beyond the $2.50 we initially assumed. Okay, given that it’s easy math. $6.60 – $2.50 would mean stop loss FAS at $4.10.

On the upside limit portion of the trade, I’m happy (actually thrilled) to get out for no profit, no loss. That would mean selling at my cost basis of $6.60. It’s one of those sentiments often expressed by mice: “keep the cheese, just let me out of the trap.”

So that’s what I’ve done. I now own FAS stock ($6.60 basis) with a stop loss at $4.16 and a limit of $6.63. Good until cancelled. I threw the weird numbers in there instead of the exact $4.10 and $6.60 because that’s just the way I enter orders.

Now I can rest knowing my foray in FAS short straddles will cost me a max of $2.50. And who knows, maybe I get this lesson for free.

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One Response to “FAS straddle trade fails”

  1. Anonymous Says:

    Read Lee Lowell’s book about option trading. He also writes for various trading magazines. You can read some of his articles on the net.

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