For those who expect a move up or down in the OEX index over a given timeframe, buying an OEX straddle might be an appropriate strategy to consider. If expectations of an OEX move come true, an investor is positioned to profit on either the upside by owning a call or the downside by owning a put at the same time.
At expiration, the profit potential on the upside from the long call is theoretically unlimited. On the downside the profit potential from the long put is substantial, limited only by the OEX declining to no less than zero. The maximum loss for the long straddle is limited to the total premium paid for the call and put, and will generally occur at expiration with the OEX closing at the straddle’s strike price and both at-the-money options expiring at-the-money and with no value.
Time decay has an especially negative effect on a long straddle because this decay is simultaneously working against the straddle owner on two long options, a call and a put. The straddle owner is also especially vulnerable to changing volatility while holding the straddle. A decrease in volatility has a simultaneous negative effect on both the long call and long put. On the other hand, an increase in volatility will have a positive effect on the market prices of both the call and the put, which can possibly overcome the natural time decay in their values and result in a profit without a move in the OEX index. This might be another motivation for purchasing the straddle in the first place.
Selling vs. Exercising Expiring OEX Options
Remember that OEX options have American-style exercise and P.M settlement characteristics. An investor with a long call or put position may sell that position, if it has market value, on any day up to and including the last trading day, usually the Friday preceding the expiration date. A long OEX option may also be exercised at any time up to its last trading day. However, the OEX’s exercise settlement value on the day of exercise may or may not be the observed level of OEX at the close of the stock market (3:00 p.m. Central Time). The settlement value is officially reported, and an OEX option’s cash settlement amount calculated, after all component stocks of the OEX have closed for trading and their closing prices reported, which generally occurs before the close of OEX option trading.
In other words, an option that is in-the-money (or out-of-the-money) at the close of the stock market (3:00 p.m.) may or may not be so afterwards when the official OEX exercise settlement value is reported.
Option Premium and Exercise Style
Investors may observe that American-style options trade at higher relative value than European-style options with similar contract size. This is because investors may pay more for American-style contracts in exchange for the right of early exercise (before expiration).