Tim Olson
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34 lines
1.6 KiB
Markdown
34 lines
1.6 KiB
Markdown
---
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description: "A volatility strategy buying an ITM call at K1 and an ITM put at K2 > K1, profiting from a large move in either direction at higher cost than a straddle."
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tags: [options, volatility, neutral, guts]
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---
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# Long Guts
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**Section**: 2.24 | **Asset Class**: Options | **Type**: Volatility
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## Overview
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The long guts is a volatility strategy consisting of a long position in an ITM call option with strike K1 and a long position in an ITM put option with strike K2 (K2 > K1). This is a net debit trade. Because both options are ITM, this strategy is more costly to establish than a long straddle position. The trader's outlook is neutral. This is a capital gain strategy. We assume D > K2 - K1.
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## Construction
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- Buy 1 ITM call option at strike K1
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- Buy 1 ITM put option at strike K2 (K2 > K1), same expiry
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Net debit: D (assumed D > K2 - K1)
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## Payoff Profile
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f_T = (S_T - K1)+ + (K2 - S_T)+ - D
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- Upper breakeven: S*_up = K1 + D
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- Lower breakeven: S*_down = K2 - D
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- Max profit: P_max = unlimited (stock can move far in either direction)
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- Max loss: L_max = D - (K2 - K1) (if K1 <= S_T <= K2; intrinsic value offsets some debit)
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## Key Conditions / Signals
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- Neutral directional view; expects a very large move but uncertain of direction
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- More expensive than a straddle but the ITM options provide intrinsic value floor
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- Max loss is reduced by the intrinsic spread K2 - K1 relative to the full debit
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## Notes
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The assumption D > K2 - K1 prevents risk-free arbitrage. The intrinsic value of the ITM options (K2 - K1) offsets part of the debit, making the maximum loss smaller than for a straddle with the same debit D. Both options have positive delta at entry.
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