Identifying Triangle Patterns and Buying Straddles

One of my favorite strategies is to buy a straddle with at least 60 days until expiration, when a stock is in a triangle pattern. What is a straddle? It is the purchase of an equal amount of call options and put options with the same strike price and expiration date. Your maximum loss is the total amount paid for the straddle, and your profit potential is technically unlimited – see the image below.

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This is a low risk options play that counts on a large and rapid move in price. There are two things that can hurt you with a long straddle: 1) drop in volatility AND 2) time. When volatility decreases the option value (premium) decreases (effect of vega), and as time goes on the premium decays (effect of theta). I personally do not like to employ this strategy near earnings announcements as the volatility drops significantly after earnings are announced.

What is a triangle pattern? It is the convergence of two trendlines in the shape of a triangle, with the stock price remaining between the lines. You have symmetrical, ascending, and descending triangles, and all of these are fine, but the scan that I have created (I have a custom scan that I use in Tradestation) searches for symmetrical triangle patterns. A symmetrical triangle pattern is shown below.

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When I employ this strategy I am not looking for big gains. I will take profit between 10% and 20% of the cost of the straddle, and I will typically take losses after a week or two if there is no movement, or if I lose approximately 10% of the cost of the straddle.

I will be posting scan results with some straddle opportunities this weekend when I find some more free time.

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