Options Trading Tutorial

Scottrade does not allow spreads or straddle option trading, saying that it is too risky. Why are spreads and

straddles considerred so risky?

Public Comments

1. by spreads and straddle trading i think that you mean when you take both positions and your gain is a result of size of the increase or decrease of the market. for example if the market does not move and you have got a straddle you can make money. if this is correct then i think that the reason that they view it as being risky is because if people can gain money through guessing the spread it can alter the way that the market works you might not have people taking opposite positions that is needed for a market to operate well.
2. They dont let you sell NAKED options, which means you dont own the stock you are writing the options for. Examples: The stock is at $9. You buy the Dec 10 call for $1 and sell the Nov 10 call for .50. You keep the net .50 of the difference. Many brick and mortar brokerages consider you covered, because theoretically if the stock went to $20, your Dec option would cover the short Nov call. But people have still lost LOTS of money, by trying to time the sales and purchase to cover. I know it looks easy, but it's not, and Scottrade (and most of the other online brokers) appeal to a retail customer, who typically lose money, and exotic trades like straddles only get them poorer faster. BTW, you could legally do it if you owned the stock. Example, you sell a covered call option on a stock you own, and buy the same call a month (or more) out. If the stock goes up, you get called (have to sell ) the covered call, BUT the option for the month out goes up (usually much more) in proportion. Unfortunately you cant do a short straddle, which means you sell the more expensive option, buy the cheaper option for "insurance" and pocket the cash difference. Lastly, if you dont know why they are so risky, it's good that Scottrade doesnt let you do it and get in trouble.
3. I THINK it has something to do with how long you have been trading options AND what kind of an account you set up w/ Scottrade. I KNOW they are working on a new format to allow more exotic/complicated option trades. This morning in our trading chat room, the subject of straddles arose. It was a generally agreed straddles should never be traded at any time for any reason. I agreed with the other folks. Thanks for asking your Q! I hope my answer helped make things a little clearer. VTY, Ron Berue Yes, that is my real last name!
4. <<<Why are spreads and straddles considerred so risky?>>> First of all, a straddle is a spread. Straddles and strangles are generally considered some of the riskiest spreads, whether you are long or short. However, spreads are almost always less risky than unhedged (long or short) directional positions with the same number of contracts per leg. For Scottrade to not allow them because they are "too risky" shows ignorance on the part of Scottrade decision makers. For what it's worth, I have several times seen other option traders comment that Scottrade is one of the worst brokerages for trading options.