Guts

Guts

Post By - Laxmi Mahera
Review By : Rohan Sharma
Updated on : October 26, 2021

Basics Concepts – Guts

Description - Guts

The Guts is a simple adjustment to the Strangle, but this adjustment makes it more expensive.
Instead of buying OTM options, we buy ITM calls and puts, which creates a higher cost basis.
We buy higher strike puts and lower strike calls with the same expiration date so that we can profit from the stock soaring up or plummeting down.
Buy ITM (lower) strike calls, preferably with near to expiration.
Buy ITM (higher) strike puts with the same expiration.

Introduction to Guts

Outlook

With Guts, your outlook is direction neutral. You are looking for increasing volatility with the stock price moving explosively in either direction.

Rationale

To execute a neutral trade for a capital gain whilst expecting a surge in volatility.
Ideally you are looking for a scenario where Implied Volatility is currently very low, giving you low option prices, but the stock is about to make an explosive move—you just don’t know which direction.
Guts are more expensive than Strangles because you are buying ITM options on both sides, as opposed to buying OTM options.
a Guts is prohibitively expensive, and it would be better to carry out a long Strangle instead.

Net Position

This is a net debit transaction because you have bought calls and puts.
Your maximum risk on the trade itself is limited to the net debit of the bought calls and puts less the difference between the strikes.
Your maximum reward is potentially unlimited.

Effect of Time Decay

Time decay is harmful to the Guts. Never keep a Guts into the last month to expiration because this is when time decay accelerates the fastest.

Time Period to Trade

We want to combine safety with prudence on cost. Therefore the optimum time period to trade Guts

Breakeven Down = Lower strike – [Net debit – difference between strikes]

Breakeven Up = [Higher strike] + [Net debit – difference between strikes]

Steps to Trading a Guts

Steps In

Actively seek chart patterns that appear like pennant formations, signifying a consolidating price pattern.
Try to concentrate on stocks with news events and earning reports about to happen within a weeks.
Choose a stock price range you feel comfortable with.

Steps Out

Manage your position according to the rules defined in your Trading Plan.
Exit either a few days after the news event occurs where there is no movement or after the news event where there has been profitable movement.
If the stock thrusts up, sell the call (making a profit for the entire position) and wait for a retracement to profit from the put.
If the stock thrusts down, sell the put (making a profit for the entire position) and wait for a retracement to profit from the call.
Try to avoid holding into the last month; otherwise, you’ll be exposed to serious time decay.

Exiting the trade - Guts

Exiting the Position

With this strategy, you can simply unravel the spread by selling your calls and puts.
You can also exit only your profitable leg of the trade and hope that the stock retraces to favor the unprofitable side later on.

Mitigating a Loss

Sell the position if you have only one month left to expiration. Do not hold on, hoping for the best, because you risk losing your entire stake.

Advantages and Disadvantages

Advantages

Profit from a volatile stock moving in either direction.
Capped risk
Uncapped profit potential if the stock moves.

Disadvantages

Significant movement of the stock and option prices is required to make a profit.
Very expensive due to both options being ITM.
Bid/Ask Spread can adversely affect the quality of the trade.
Psychologically demanding strategy.

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