Long Guts - Overview
The long guts option strategy is a volatility trade that is created when the trader believes that there will be a sharp move up, or down in the underlying. This options strategy involves buying an equal amount of ITM calls and puts, which have the same expiration date. This strategy is a limited risk, unlimited return, direction neutral strategy requiring a net debit to initiate the position. The long guts is very similar to the straddle and strangle; however, it uses in the money options instead.
This strategy is usually used by traders who not sure as the direction of the underlying but are sure about future volatility in it. Many times, traders use this to profit off of earnings releases or other market moving items such as a move in the federal funds rate by the fed.
Long Guts Risk Characteristics
In reviewing the risk characteristics of the long guts strategy, you can see that the price zone between the two option strike prices is where you will lose the most amount of money. Once you break further away from the strikes, profits will start to be realized
Options strategy - Long Guts
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Breakevens & Profit Potential
The breakeven calculations are pretty straight forward for the long guts.
Transaction Cost = Long Put Premium + Long Call Premium
Once we have the transaction cost for this trade, we can add it to the long call strike and subtract it from the long put price to arrive at our breakevens.
Breakeven Calculations
b1* = Long Put Strike - Transaction Cost
b2* = Long Call Strike + Transaction Cost
Risk Calculations
The maximum loss always occurs between the long call and long put strike price, you can see that in our risk characteristics but we will walk through why in our example below. It can be calculated with the following formula:
Maximum Loss Potential = (Long Put Strike - Long Call Strike) - Transaction Cost
Profit Calculations
Once the underlying moves past these breakeven prices, the strategy will return dollar for dollar on any move up or down.
Profit When Underlying is above b1* = Underlying Price at Expiration - Long Call Strike - Transaction Cost
Profit When Underlying is below b2* = Long Put Strike Price - Underlying Price at Expiration - Transaction Cost
The spreadsheet will take care of all of these calculations for you. You may modify the values in the highlighted cells in order to represent your options. The breakeven, risk, and profit calculations will all be updated for you.
Related Topics
Options strategies:
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