The Long Gut Spread is a volatile options trading strategy designed to profit when the underlying stock moves strongly upwards or downwards.
The Long Gut Spread is a cousin of the Long Straddle and the Long Strangle with the only difference being that In The Money options are used
instead. The Long Gut Spread is useful when
no At The Money options are available when you want to use a Straddle. In fact, since exactly at the money options are so rare,
the Long Gut Spread using in the money options and the Long Strangle using Out Of The Money options are far more commonly used than the
In short, the Long Gut Spread is simply a Straddle using In The Money options instead of At The Money options.
Straddles, Strangles and Long Guts form the family of basic volatile options strategies and each have their own pros and cons. Here's a comparison table:
Cost of Position
When To Use Long Gut Spread?
One should use a Long Gut Spread when one is confident of a strong move in the underlying asset but is uncertain as to which direction it may be.
Situations that creates an uncertainty as to the direction of move may be just before an important corporate announcement, court verdict, earnings announcement etc...
Establishing a Long Gut Spread simply involves the simultaneous purchase of an
in the money (ITM)call option and an in the money (ITM)
put option on the underlying asset. In the money call options give you unlimited profit to upside when the stock moves higher with limited loss to down side while in the money put options give you unlimited profit to downside when the underlying stock moves lower with limited loss to upside. Combine them both and you will have a Long Gut Spread which profits when the underlying stock moves up or down. This strategy makes full use of the unlimited profit and limited risk characteristics of
Long Gut Spread Example :
Assuming QQQQ at $44.
Buy To Open QQQQ Jan43Call, buy To Open QQQQ Jan45Put
You would notice immediately that
the components and concept for Long Gut Spreads are exactly the same as a Straddle or Strangle with the only difference being that
in the money options are used instead.
Trading Level Required For Long Gut Spread
A Level 2 options trading account that allows the buying of both call options and put options is needed for the Long Gut Spread. Read more about Options Account Trading Levels.
Profit Potential of Long Gut Spread :
Long Gut Spreads profit in 2 ways. Firstly, if the stock goes up, the Long call option goes up in price along with the stock price while the Long put option eventually expires out of the money. Secondly, if the stock goes down, the Long put option goes up in price along with the drop in the stock price while the Long call option eventually expires out of the money. This results in unlimited profits to upside and downside.
Profit Calculation of Long Gut Spread:
Maximum Profit = Unlimited.
Profit % If Stock Goes Up = [(Price Of Stock At Expiration - Call Options Strike Price) - Net Debit Paid] / Net Debit Paid
Profit % If Stock Goes Down = [(Put Options Strike Price - Price Of Stock At Expiration) - Net Debit Paid] / Net Debit Paid
Maximum Loss Possible = Net Debit Paid - (Strike Price of Long Put - Strike Price of Long Call)
Long Gut Spread Example Continued :
Bought the JAN 43 Call for $1.50, Bought the JAN 45 Put for $1.60
Assuming QQQQ close at $50 at expiration.
Profit % = [(50 - 43) - 3.10] / 3.10 = 125%
Maximum Loss Possible = 3.10 - (45 - 43) = $1.10
Risk / Reward of Long Gut Spread:
Upside Maximum Profit: Unlimited
Maximum Loss: Limited to calculated maximum loss
Break Even Points (Profitable Range) of Long Gut Spread:
Long Gut Spreads are profitable as long as the price of the underlying stock exceeds either the upper or lower breakeven point.
Upper Break Even Point = Call Strike + Net Debit
Net Debit=$3.10 , Call Strike = $43.00
Upper Breakeven Point = $43.00 + $3.10 = $46.10.
Lower Break Even = Put Strike - Net Debit
Net Debit = $3.10 , Put Strike = $45.00
Lower Breakeven Point = $45.00 - $3.10 = $41.90.
Advantages Of Long Gut Spread:
Able to profit no matter if the underlying asset goes up or down.
Unlimited profit if the underlying asset continues to move in one direction.
Saves time from having to analyse if a stock will go up or down ahead of major news releases.
Loss is limited.
If volatility is low at the time of purchase and volatility rises, both options could profit even without an appreciable change in the stock price.
No need to buy the underlying asset which is good for investors with small funds.
Narrowest breakeven points of the 3 basic volatile options strategies.
Disadvantages Of Long Gut Spread:
There will be more commissions involved than simply buying call or put options.
You can lose more money if the underlying asset stayed stagnant than if you simply bought a call or put option.
If volatility falls for both or either option, the position could lose with or without a price swing in the underlying asset.
Most expensive of the 3 basic volatile options strategies.
Alternate Actions for Long Gut Spreads Before Expiration :
1. If the underlying asset has moved beyond its breakeven point and is expected to continue to move strongly in the same direction,
one could sell the out of the money option so that some value is recovered from it.
2. If one is very aggressive and confident that the underlying asset will continue to move strongly in the same direction, one could
then use the money gained from selling the
out of the money option, and buying more contracts of the in the money option.
Important Disclaimer :
Options involve risk and are not suitable for all investors.
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