Long Gut Option Trading: Options, Futures, Derivatives & Commodity Trading

Long Gut Option Trading

Continuing further from the Part I of this article: Long Gut Option Trading
What are the breakeven points for the Long Gut Option trading position? Long Gut Option

Break even points are the points or spots when there is no profit - no loss for the option trader. i.e. they are the points either side of which there is a profit area and a loss area.

Long Gut Option Trading Profit and Loss Calculation

The Long Gut option position will have 2 break even points - one on the upper side and one on the lower side
Upper Breakeven Point = Net Premium Paid + Strike Price of Long Call
i.e. $16 + $45 = $61
Above $61, the Long Gut option position holder will be in profit. Below $61, he will be in loss.

Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid
i.e. $55 - $16 = $39
Below $39, the Long Gut option position holder will be in profit. Above $39, he will be in loss.
In summary, the Loss region for Long Gut option position is from $39 to $61, while profit region is above $61 or below $39.

What is the maximum profit in the Long Gut Option trading?
Although it is said that there is unlimited profit in the Long Gut option position, but it is true only for the upward side. On the downward side, it is limited profit.

For the long gut option buyer, the maximum profit is unlimited on the upward side as the underlying stock price may continue to increase to any extent.
On the downward side, the lowest price is Zero (i.e. company going bankrupt) hence the profit is limited on the downward side

Profit will be achieved only when:
Price of Underlying remains less than (the Strike Price of Long Put - Net Premium Paid)
Price of Underlying remain greater than the (Strike price of the Long Call + Net Premium Paid)

Profit = Price of Underlying - Strike Price of Long Call - Net Premium Paid (Upward Movement)
Profit = Strike Price of Long Put - Price of Underlying - Premium Paid (Downward Movement)

Do note that one must also deduct the options trading brokerage and commission for trading in options.

What is the maximum loss in a Long Gut Option position?
The Long Gut option trader will be in loss if the stock price remains in the loss region, as mentioned above.

Max Loss = Net Premium Paid + Strike Price of Long Put - Strike Price of Long Call + Commissions Paid
In case of the above example,
Max Loss = $16 + $55 - $45 + Brokerage = $26 + Brokerage & Commissions

When is it profitable to trade a Long Gut Option position?
The long gut option should be traded when you expect a big movement in underlying stock or index price, but the direction is not certain.

What are the risks in trading Long Gut Options?
Trading Long Guts may look good high potential profit giving trades, but beware of the few things:
- You will get into 2 long positions i.e. 2 buys. hence you need to pay premium for the 2 ITM positions upfront leading to more capital requirements
- You will get hit by time decay adversely which might eat away all profits (See Options Time Decay: Explained with Examples)
- Remember, markets are efficient. If you know that the stock is going to make a big move, so will other traders. Hence the price might already have that expectations factored in the ITM call and put prices and you might end up paying high price for both call and put option buy.
- Volatility will also have an impact on the final output. The options trader will benefit if after getting into the Long Gut, the volatility increases.
- Although this is known as the direction neutral strategy, considering the price you have to pay for 2 options ( 1 call and 1 put), the price movement has to be high enough for the long gut position to be profitable
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