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.This strategy is usually used by traders who not sure as the direction of the underlying but are sure about future volatility in it. Many times, traders use this to profit off of earnings releases or other market moving items such as a move in the federal funds rate by the fed.
Loss occurs when both options expires in the money. Net loss is calculated by deducting the amount earned by exercising both call and put options from original debt. Short guts options trading strategy is also available, which is practiced when traders expect least volatility in underlying stock price.
Unlimited Profit Potential
Large gains for the long guts strategy is attained when the underlying stock price makes a very strong move either upwards or downwards at expiration. The move in the underlying stock price must be strong enough such that either the long call or the long put rise enough in value to offset the loss incurred by the other option expiring worthless.
The formula for calculating profit is given below:
- Maximum Profit = Unlimited
- Profit Achieved When Price of Underlying < Strike Price of Long Put – Net Premium Paid OR Price of Underlying > Long Call + Net Premium Paid
- Profit = Price of Underlying – Strike Price of Long Call – Net Premium Paid OR Strike Price of Long Put – Price of Underlying – Premium Paid
When to use: When you are bullish on volatility but are unsure of market direction.
A long guts has the same profile as a Long Strangle. The difference is that with a guts you only buy ITM options. A strangle you buy OTM options.
