The Straddle Trading Strategy

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How a Straddle Option Can Make You Money No Matter Which Way the Market Moves

This options strategy profits from big moves — in either direction.

Image source: Getty Images.

Options strategies can seem complicated, but that’s because they offer you a great deal of flexibility in tailoring your potential returns and risks to your specific needs. One interesting strategy known as a straddle option can help you make money whether the market goes up or down, as long as it moves sharply enough in either direction. The straddle option is a neutral strategy in which you simultaneously buy a call option and a put option on the same underlying stock with the same expiration date and strike price. As long as the underlying stock moves sharply enough, then your profit is potentially unlimited.

What goes into a straddle option?

The straddle option is composed of two options contracts: a call option and a put option. To use the strategy correctly, the two options have to expire at the same time and have the same strike price — the price at which the option calls for the holder to buy or sell the underlying stock. Specifically, the call option gives you the right to buy the stock at a set strike price at any time before the option’s expiration. The put option gives you the right to sell the same stock at the same set strike price before expiration.

To buy the two options, you’ll need to pay one premium for the call option and another premium for the put option. As you’ll see below, the total you pay in premiums represents your maximum potential loss on the straddle option position.

When does a straddle option make you money?

Straddle option positions thrive in volatile markets because the more the underlying stock moves from the chosen strike price, the greater the total value of the two options. Given the way that the straddle is set up, only one of the options will have intrinsic value when they expire, but the investor hopes that the value of that option will be enough to earn a profit on the entire position.

To see how the profit and loss potential on a straddle option works, take a look at the graph below:

Image source: Author.

Here, this example involves buying straddle options with a strike price of $50 and paying a total of $10 in premium for the two options. In this case, the worst-case scenario is if the stock doesn’t move and remains at $50 at expiration. If that happens, both options expire worthless, and you’ll lose the $10 you paid for the options.

On the other hand, if the stock moves sharply in one direction or the other, then you’ll profit. For instance, if the stock falls to $20, then the call option expires worthless, but the put option has a value of $30 at expiration. When you net out the $10 you paid in premium, that leaves you with a net profit of $20 on the straddle position.

Notice that if the stock rises to $80, the end result is the same. Here, it’s the put option that expires worthless and the call option that has a value of $30 at expiration, but the profit of $20 is the same.

When doing a straddle makes the most sense

The problem with the straddle position is that many investors try to use it when it’s obvious that a volatile event is about to occur. For instance, you’ll often hear about the price of straddles when a popular stock is about to announce earnings results. Because the stock is almost certain to move in one direction or another, straddles are often at their most expensive preceding known market-moving events.

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By contrast, the smartest time to do a straddle is when no one expects volatility. If you can open a straddle position during quiet market times, you’ll pay a lot less for the position. Then, the stock doesn’t have to move as much in order to generate a profit. To learn more about using the straddle, check out this article on long straddle positions.

Straddle options let you profit regardless of which direction a stock moves. The enemy of the straddle is a stagnant stock price, but if shares rise or fall sharply, then a straddle can make you money in both bull and bear markets.

Business Jargons A Business Encyclopedia

Definition: The Straddle Positioning is one of the positioning strategy adopted by the marketers to position their product in two categories simultaneously.

In other words, the positioning strategy adopted to create a dual image of the product in the minds of the customer is called as Straddle positioning.

In straddle positioning, the marketers use the blend of POP (points of parity) and POD (points of difference) to arrive at the categories for which they are positioning their products.

Examples of Straddle Positioning

  1. When BMW entered the market, gave a stiff competition to other luxurious cars because at that time, all the luxury cars focused on its luxury and overlooked the performance factor. BMW came with the dual positioning as luxurious (POP) as well as performance (POD) and substantiated this by its slogan “the ultimate driving machine”.
  2. In the case of Scorpio, it came with the dual positioning as luxury as well as the adventure that helped the marketers to gain dual benefit in case of a luxury segment as well as in the adventure segment. In the case of the luxury segment, the luxury is POP and the adventure is POD and for the adventure segment, luxury is POD and the adventure is POP.
  3. The dual positioning of Dominos, product attributes as well as desirable benefits. The product attributes (POP) means providing the fresh pizza and the desirable benefit (POD) are the home delivery that it offers.

Positioning the product in a single category is more convenient for the marketers since its success depends on a single factor, but in the case of straddle positioning, the marketers have to ensure that the categories for which the positioning is done are successfully met by the product. It can be a great hit if applied correctly else it may result in the huge losses if the product fails to meet its promises.

Straddle

What Is a Straddle?

A straddle is a neutral options strategy that involves simultaneously buying both a put option and a call option for the underlying security with the same strike price and the same expiration date.

A trader will profit from a long straddle when the price of the security rises or falls from the strike price by an amount more than the total cost of the premium paid. Profit potential is virtually unlimited, so long as the price of the underlying security moves very sharply.

Key Takeaways

  • A straddle is an options strategy involving the purchase of both a put and call option for the same expiration date and strike price on the same underlying.
  • The strategy is profitable only when the stock either rises or falls from the strike price by more than the total premium paid.
  • A straddle implies what the expected volatility and trading range of a security may be by the expiration date.

Straddles Academy

Understanding Straddles

More broadly, straddle strategies in finance refer to two separate transactions which both involve the same underlying security, with the two component transactions offsetting one another. Investors tend to employ a straddle when they anticipate a significant move in a stock’s price but are unsure about whether the price will move up or down.

A straddle can give a trader two significant clues about what the options market thinks about a stock. First is the volatility the market is expecting from the security. Second is the expected trading range of the stock by the expiration date.

Putting Together a Straddle

To determine the cost of creating a straddle one must add the price of the put and the call together. For example, if a trader believes that a stock may rise or fall from its current price of $55 following earnings on March 1, they could create a straddle. The trader would look to purchase one put and one call at the $55 strike with an expiration date of March 15. To determine the cost of creating the straddle, the trader would add the price of one March 15 $55 call and one March 15 $55 put. If both the calls and the puts trade for $2.50 each, the total outlay or premium paid would be $5.00 for the two contracts.

The premium paid suggests that the stock would need to rise or fall by 9% from the $55 strike price to earn a profit by March 15. The amount the stock is expected to rise-or-fall is a measure of the future expected volatility of the stock. To determine how much the stock needs to rise or fall, divide the premium paid by the strike price, which is $5 / $55, or 9%.

Discovering the Predicted Trading Range

Option prices imply a predicted trading range. To determine the expected trading range of a stock, one could add or subtract the price of the straddle to or from the price of the stock. In this case, the $5 premium could be added to $55 to predict a trading range of $50 to $60. If the stock traded within the zone of $50 to $60, the trader would lose some of their money but not necessarily all of it. At the time of expiration, it is only possible to earn a profit if the stock rises or falls outside of the $50 to $60 zone.

Earning a Profit

If the stock fell to $48, the calls would be worth $0, while the puts would be worth $7 at expiration. That would deliver a profit of $2 to the trader. However, if the stock went to $57, the calls would be worth $2, and the puts would be worth zero, giving the trader a loss of $3. The worst-case scenario is when the stock price stays at or near the strike price.

Real World Example

On October 18, 2020, the options market was implying that AMD’s stock could rise or fall 20% from the $26 strike price for expiration on November 16, because it cost $5.10 to buy one put and call. It placed the stock in a trading range of $20.90 to $31.15. A week later, the company reported results and shares plunged from $22.70 to $19.27 on October 25. In this case, the trader would have earned a profit because the stock fell outside of the range, exceeding the premium cost of buying the puts and calls.

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