Long Straddle

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How many times have you been in a situation wherein you take a trade after much conviction, either long or short and right after you initiate the trade the market moves just the other way round? All your strategy, planning, efforts, and capital go for a toss. In fact this is one of the reasons why most professional traders go beyond the regular directional bets and set up strategies which are insulated against the unpredictable market direction. Over the next few chapters we will straddle options strategy example some of the market neutral strategies and how a regular retail trader can execute such strategies.

Long straddle is perhaps the simplest market neutral strategy to implement. The market can move in any direction, but it has to move. To implement a long straddle all one has to do is —. Here is an example which explains the execution of a long straddle and the eventual strategy payoff. Long straddle would require us to simultaneously purchase the ATM call and put options. As you can see from the snapshot above, CE is trading at 77 and PE is trading at The simultaneous purchase of both these options would result in a net debit of Rs.

The idea here is — the trader is long on both the call and put options belonging to the ATM strike. Hence the trader is not really worried about which direction the market would move. If the market goes up, the trader would expect to see gains in Call options far higher than the loss made read premium paid on the put option. Similarly, if the market goes down, the gains in the Put option far exceeds the loss on the call option.

Hence the market direction straddle options strategy example is meaningless. Let us break this down further and evaluate different expiry scenarios. Scenario 2 — Market expires straddle options strategy example lower breakeven This is a situation where the strategy neither makes money nor loses any money. If you think about it, with respect to the ATM strike, market has indeed expired at straddle options strategy example lesser value.

So therefore the put option makes money. However, the gains made in the put option adjusts itself against the premium paid for both the call and put option, eventually leaving no money on the table. Scenario 3 — Market expires at at the ATM strike Atthe situation is quite straight forward as both the call straddle options strategy example put option would expire worthless and hence the premium paid would be gone. The loss straddle options strategy example would be equivalent to the net premium paid i.

Straddle options strategy example 4 — Market expires at upper breakeven This is similar to the 2 nd scenario we discussed. This is a point at which the strategy breaks even at a point higher than the ATM strike.

Hence the strategy would breakeven at this point. Scenario 5 — Market expires atcall option makes money Clearly the market in this scenario is way above the ATM mark. Straddle options strategy example call option premiums would swell, so straddle options strategy example so that the gains in call option will more than offset the premiums paid.

Let us check the numbers —. So as you can see, the gain in call option is significant enough to offset the combined premiums paid. Here is the payoff table at different market expiry levels. As you can observe —. We can visualize these points in the payoff structure here — From the V shaped payoff graph, the following things are quite clear —.

In summary, you buy calls and puts, each leg has a limited down side, hence the combined position also has a limited downside and an unlimited profit potential. Hence the direction does not matter here. But let me ask you this — if the direction does not matter, what else matters for this strategy?

Yes, volatility matters quite a bit when you implement the straddle. I would not be exaggerating if I said that volatility makes or breaks the straddle. Have a look at this graph below — The y-axis represents the cost of the strategy, which is simply the combined premium of both the options and the x-axis represents volatility.

The blue, green, and red line represents how the premium increases when the volatility increases given that there is 30, 15, and 5 days to expiry respectively. As straddle options strategy example can see, this is a linear graph and irrespective of time to expiry, the strategy cost increases as and when the volatility increases.

Likewise the strategy costs decreases when the volatility decreases. Remember the cost of a long straddle represents the combined premium required straddle options strategy example buy both call and put options. In other words, you are likely to double your money in the straddle provided —. Now, this also means you will lose money if you execute the straddle when the volatility is high which starts to decline after you execute the long straddle.

This is an extremely crucial point to remember. Since we are long on ATM strike, the delta of both the options is close to 0. Recall, delta shows the direction bias of the position.

Given this, a 0 delta indicates that there is no bias whatsoever to the direction of the market. On the face of it a long straddle looks great. Think about it — you get to make money whichever way the market decides to move. All you need is the right volatility estimate. Therefore, what can really go wrong with a straddle?

Well, two things come in between you and the profitability of a long straddle —. Keeping the above two points plus the impact on volatility in perspective, we can summarize what really needs to work in your favor for the straddle to be profitable —. From my experience trading long straddles, they are profitable when setup around major market events and the impact of such events should exceed over and above what the market expects. Let us take the Infosys results as an example here.

If you were the set up a long straddle in the backdrop of such an event and its expectationand eventually the expectation is matched, then chances are that the straddle would fall apart. This is because around major events, volatility tends to increase which tends to drive the premium high.

So if you are to buy ATM call and put options just around the corner of an event, then you are essentially buying options when the volatility is high. When events are announced straddle options strategy example the outcome is known, the volatility drops like a ball, and therefore the premiums. This would essentially take the market by surprise and drive premiums much higher, resulting in a profitable straddle trade. You cannot setup a straddle with a mediocre assessment of events and its outcome.

This may seem like a difficult proposition but you will have to trust me here — few quality years of trading experience will actually get you to assess situations way better than the rest of the market. HI,sir How many days will it take to complete this OPtion Strategy module and how many lessons are left? Sir when u start module — Trading Psychology and Money Management.

Please Start Trading Psychology module as soon as possible. Its my opinion that without knowing Trading psychology and money management… No one can become successful trader. Ur writing skill is superb. I have been waiting for Trading Psychology straddle options strategy example for 5 months…still I think I have to wait months. OK … No Problem Sir. Please suggest me some best book. This is one of the good books on this subject — http: Yes this works out perfectly when the direction of the market trend is one sided, either well up or well down.

Sir, I am eagerly straddle options strategy example for PDF modules. When can we get it?? As they are more suitable for printing and reading. Rest would work the same way. Would there be a scenario when a long straddle is better than a long put straddle? The strategy that straddle options strategy example are talking about — isit like buying Futures plus buying put? If yes, this would be an expensive strategy as it requires margin deposits for the futures.

Sir, Long future and long put will it not straddle options strategy example equal to long call synthetic?

Its pay out will be entirely different from the long straddle. Just a minor thing. Your profit would be future price-strike price-premium if the script appreciates or strike price-future price-premium if the script depreciates. Am I right Karthick? Sushreet — I guess the best way to understand the payoff would be to actually plot it and visualize straddle options strategy example on excel. Whenever we have more than 2 option legs, the payoff are tricky and you need to visualize it to understand how they work.

Long Call and short put would make a synthetic call and its payout will be similar to that of a long futures, and yes, it is completely different from a long straddle. Thanks for point the graphics bit: Request you to kindly send somebody to explain the whole procedure of buying and selling on the website.

Meanwhile you can also go through this chapter — http: An observation which I would like to share. VIX decreases from But increase in call option is only 9 points, whereas put option decreased by 20 points. Why is the increase in call option less than put option? In this case volatility dropped and market increasedboth are favorable for the drop in Put premiums 2 Call option has gone up because the markets increased, but then volatility has dropped which limits the increase in premiums.

Shravan — you can find all the details here — http: The only two things to keep in mind while doing Straddle options strategy example — look straddle options strategy example high volume breakouts and trade only liquid straddle options strategy example

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The subject line of the email you send will be "Fidelity. A long straddle consists of one long call and one long put. Both options have the same underlying stock, the same strike price and the same expiration date. A long straddle is established for a net debit or net cost and profits if the underlying stock rises above the upper break-even point or falls below the lower break-even point.

Profit potential is unlimited on the upside and substantial on the downside. Potential loss is limited to the total cost of the straddle plus commissions. Profit potential is unlimited on the upside, because the stock price can rise indefinitely. On the downside, profit potential is substantial, because the stock price can fall to zero. Potential loss is limited to the total cost of the straddle plus commissions, and a loss of this amount is realized if the position is held to expiration and both options expire worthless.

Both options will expire worthless if the stock price is exactly equal to the strike price at expiration. A long straddle profits when the price of the underlying stock rises above the upper breakeven point or falls below the lower breakeven point. A long — or purchased — straddle is the strategy of choice when the forecast is for a big stock price change but the direction of the change is uncertain.

Straddles are often purchased before earnings reports, before new product introductions and before FDA announcements. The risk is that the announcement does not cause a significant change in stock price and, as a result, both the call price and put price decrease as traders sell both options. It is important to remember that the prices of calls and puts — and therefore the prices of straddles — contain the consensus opinion of options market participants as to how much the stock price will move prior to expiration.

The same logic applies to options prices before earnings reports and other such announcements. Dates of announcements of important information are generally publicized in advanced and well-known in the marketplace. Furthermore, such announcements are likely, but not guaranteed, to cause the stock price to change dramatically. As a result, prices of calls, puts and straddles frequently rise prior to such announcements.

An increase in implied volatility increases the risk of trading options. Buyers of options have to pay higher prices and therefore risk more. For buyers of straddles, higher options prices mean that breakeven points are farther apart and that the underlying stock price has to move further to achieve breakeven. Sellers of straddles also face increased risk, because higher volatility means that there is a greater probability of a big stock price change and, therefore, a greater probability that an option seller will incur a loss.

This means that buying a straddle, like all trading decisions, is subjective and requires good timing for both the buy decision and the sell decision. When the stock price is at or near the strike price of the straddle, the positive delta of the call and negative delta of the put very nearly offset each other. Thus, for small changes in stock price near the strike price, the price of a straddle does not change very much. This happens because, as the stock price rises, the call rises in price more than the put falls in price.

Also, as the stock price falls, the put rises in price more than the call falls. Positive gamma means that the delta of a position changes in the same direction as the change in price of the underlying stock. As the stock price rises, the net delta of a straddle becomes more and more positive, because the delta of the long call becomes more and more positive and the delta of the put goes to zero. Similarly, as the stock price falls, the net delta of a straddle becomes more and more negative, because the delta of the long put becomes more and more negative and the delta of the call goes to zero.

Volatility is a measure of how much a stock price fluctuates in percentage terms, and volatility is a factor in option prices. As volatility rises, option prices — and straddle prices — tend to rise if other factors such as stock price and time to expiration remain constant. Therefore, when volatility increases, long straddles increase in price and make money.

When volatility falls, long straddles decrease in price and lose money. This is known as time erosion, or time decay. Since long straddles consist of two long options, the sensitivity to time erosion is higher than for single-option positions. Long straddles tend to lose money rapidly as time passes and the stock price does not change. Owners of options have control over when an option is exercised. Since a long straddle consists of one long, or owned, call and one long put, there is no risk of early assignment.

There are three possible outcomes at expiration. The stock price can be at the strike price of a long straddle, above it or below it. If the stock price is at the strike price of a long straddle at expiration, then both the call and the put expire worthless and no stock position is created.

If the stock price is above the strike price at expiration, the put expires worthless, the long call is exercised, stock is purchased at the strike price and a long stock position is created.

If a long stock position is not wanted, the call must be sold prior to expiration. If the stock price is below the strike price at expiration, the call expires worthless, the long put is exercised, stock is sold at the strike price and a short stock position is created.

If a short stock position is not wanted, the put must be sold prior to expiration. Long straddles involve buying a call and put with the same strike price. For example, buy a Call and buy a Put. Long strangles, however, involve buying a call with a higher strike price and buying a put with a lower strike price. For example, buy a Call and buy a 95 Put. There are three advantages and two disadvantages of a long straddle. The first advantage is that the breakeven points are closer together for a straddle than for a comparable strangle.

Third, long straddles are less sensitive to time decay than long strangles. Thus, when there is little or no stock price movement, a long straddle will experience a lower percentage loss over a given time period than a comparable strangle.

The first disadvantage of a long straddle is that the cost and maximum risk of one straddle one call and one put are greater than for one strangle. Second, for a given amount of capital, fewer straddles can be purchased.

The long strangle two advantages and three disadvantages. The first advantage is that the cost and maximum risk of one strangle are lower than for one straddle. Second, for a given amount of capital, more strangles can be purchased.

The first disadvantage is that the breakeven points for a strangle are further apart than for a comparable straddle. Third, long strangles are more sensitive to time decay than long straddles. Thus, when there is little or no stock price movement, a long strangle will experience a greater percentage loss over a given time period than a comparable straddle.

A long strangle consists of one long call with a higher strike price and one long put with a lower strike. Reprinted with permission from CBOE. The statements and opinions expressed in this article are those of the author.

Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data. Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options.

Supporting documentation for any claims, if applicable, will be furnished upon request. Charts, screenshots, company stock symbols and examples contained in this module are for illustrative purposes only. Skip to Main Content. Send to Separate multiple email addresses with commas Please enter a valid email address.

Your email address Please enter a valid email address. Example of long straddle Buy 1 XYZ call at 3. Related Strategies Long strangle A long strangle consists of one long call with a higher strike price and one long put with a lower strike. Short straddle A short straddle consists of one short call and one short put. Please enter a valid ZIP code.