Analyze This [ATM Straddle]

Unlock the power of at-the-money (ATM) straddles and learn how they reveal market expectations for volatility and stock movement. In this episode, we break down straddle pricing, historical performance, and trading strategies to help you make more informed options decisions.

Summary – IBKR Podcasts Ep. 226

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Jeff Praissman

Hi, everyone. This is Jeff Praissman from Interactive Brokers’ podcast studio. It’s my pleasure to welcome back to our studio for our monthly podcast, Will McBride from Market Chameleon. Hey, guys, how are you? 

Dmitry Pargamanik

Hey, Jeff, thank you for having us. 

Will McBride

Hey, Jeff, always a pleasure. Thanks for having us. 

Jeff Praissman

Yeah, and we just finished up a great webinar on tracking at-the-money straddles. I’m happy to have you guys here, like always, swinging by the studio afterward to take—I don’t want to say a deeper dive, but maybe a different dive—into the topic for our podcast listeners. 

For those listening at home, you can always catch the webinar, whether you signed up for it or not. Just go to our website, look for “Contributors,” then find Market Chameleon. You’ll see all their previous podcasts and webinars there. I highly recommend checking them out, especially if you’re interested in this subject. 

To get started, let’s begin with the basics. What is a straddle, and what do you mean by “at the money”? 

Dmitry Pargamanik

Yeah, thanks, Jeff. A straddle is an options strategy where you simultaneously either buy a call and a put at the same strike price and expiration or sell both the call and the put at the same strike and expiration. 

An at-the-money straddle refers to the strike price closest to the stock’s current trading price. You won’t always find a strike that exactly matches the stock price, but the closest one is considered at the money. Ideally, an exact at-the-money strike would mean the stock price equals the strike price, but in practice, we look at the closest available one. 

This strategy is designed to capitalize on volatility—stock movement in either direction. That’s why it’s called a straddle: you have both a call and a put to cover price swings up or down. 

Jeff Praissman

Why are at-the-money straddles particularly relevant compared to other straddles? What does their pricing tell us about the market? 

Dmitry Pargamanik

The key thing about at-the-money straddles is that they tend to be the most liquid options. Not always, but typically, you’ll find that the highest liquidity and volume concentrate around strikes near the money. 

At-the-money straddles also provide a strong indication of the market’s anticipated stock movement. They offer one of the best representations of expected volatility and price movement between now and expiration. 

Other strikes, such as out-of-the-money options, are influenced by skew in implied volatility. Those strikes price in the potential for unexpected moves—like a big gap up or down. But the at-the-money straddle gives us a pure view of the market’s consensus expectations for near-term volatility and movement. 

Jeff Praissman

Just to simplify it for our listeners—if a stock is trading at $50 and the 50-strike straddle is trading for $5, the market is essentially expecting a $5 move. It doesn’t know whether it’ll go up or down, but it’s indicating an expected range between $45 and $55. Correct? 

Dmitry Pargamanik

Exactly! That would imply the market is pricing in a 10% move in either direction. The break-even points for both the buyer and seller would be at $45 and $55. 

Jeff Praissman

What timeframes do you track for straddles? Are you looking at expirations six months out, or do traders focus on shorter-term options? 

Dmitry Pargamanik

Straddles closer to expiration—shorter-term ones—are typically more relevant. Even when we track a monthly straddle, we observe it week to week. 

The reason shorter-term straddles are important is that they provide more certainty. For example, in the coming week, a stock might have earnings or an ex-dividend date. These are known events that traders have already factored in. 

By tracking week-to-week movements, we can analyze how well the market prices potential volatility and stock movements. 

Jeff Praissman

Cutting right to the chase—how do traders actually use this pricing information? If a straddle is priced at $5, they still don’t know if the stock will move up or down, so what’s the practical application here? 

Dmitry Pargamanik

When analyzing straddles, traders ask a few key questions: 

1. Do straddles tend to underprice or overprice actual volatility? 

2. How well do they predict actual stock movement? 

3. If there’s an error, how large is it? 

A straddle is essentially a forecast—a forward-looking measure of expected volatility and stock movement. Understanding whether the market consistently overprices or underprices these movements can help traders make better decisions. 

Additionally, traders compare current straddle prices to historical levels. Is the current price high, low, or within a normal range? This kind of historical benchmarking helps assess risk and potential trading opportunities. 

Jeff Praissman

So not only are you looking at short-term expirations, but you’re also reviewing past performance to evaluate accuracy? 

For instance, if stock ABC’s straddle is priced at $5 and historically, that price has been accurate, then traders may trust it. But if stock XYZ’s straddle is priced at $9 and has been highly inaccurate in the past, traders might be more cautious. Is that a fair way to summarize it? 

Dmitry Pargamanik

Exactly. How well the market prices risk relative to actual movements is a key question for traders. By tracking past performance, they can assess whether straddles tend to be overpriced or underpriced on certain stocks. 

Jeff Praissman

If someone is interested in a stock like Apple, should they compare its straddles to those of similar companies? What insights can that provide? 

Dmitry Pargamanik

Absolutely. This is similar to a pairs trading strategy, where you sell one security and buy another based on relative valuation. 

With straddles, you can compare two similar stocks with similar betas. If one stock’s straddle looks undervalued while another’s appears overvalued, that could signal an opportunity for a relative value trade. 

Professional traders often trade baskets of securities using this type of cross-asset analysis. 

Jeff Praissman

This was a great discussion. The webinar earlier was fantastic as well. I really appreciate you guys coming by. 

For our listeners, you can catch Market Chameleon every day on their YouTube channel, where they break down market trends. Always a great place for insights. 

Looking forward to next month’s conversation! Thanks again. 

Dmitry Pargamanik

Thanks, Jeff! 

Jeff Praissman

All right, thanks, guys.