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Description and use

Long Straddle option is a popular strategy. To establish the position, the trader has to buy a Long Put and a Long Call with same strike prices and expiration. The investment will be profitable whether the share prices are falling or increasing. The investment has unlimited profit and limited risk. Profit is generated when the movement of the share prices covers the premiums paid. The optimal duration is three months. Time decay has a negative effect on the value, especially during the last month before expiration. The underlying share should show pennant or flag shapes on charts. The volatility of the share should be strongly decreasing. The direction of the market is neutral. Ideally, the expected implied volatility is low. The strategy is a net debit investment. The maximum profit is potentially unlimited and the maximum loss is limited.

  • Type: Neutral
  • Transaction type: Debit
  • Maximum profit: Unlimited
  • Maximum loss: Limited
  • Strategy: Volatility strategy

Opening the position

Straddle Option Positions

Straddle Option Positions

  • Buy (ATM) Put options.
  • Buy (ATM) Call options (same expiration and strike price as the Put options’).

Steps

Entry:

  • Look for shares showing pennant or similar shapes on charts.

Exit:

  • When share prices are increasing, sell the Call option.
  • When share prices are decreasing, sell the Put option.

Basic characteristics

Maximum loss: Net debit.

Maximum profit: Unlimited.

Time decay: Time decay has a negative effect on the value, especially during the last month before expiration.

Lower breakeven point: Strike price - Net debit.

Upper breakeven point: Strike price + Net debit.

Advantages and disadvantages

Advantages:

  • Profit is generated when the share price changes in any direction.
  • Limited loss.
  • The profit is potentially unlimited when share prices are moving.

Disadvantages:

  • Expensive.
  • The share price must change significantly to generate profit.
  • High Bid/Offer spread can have a negative influence on the position.

Closing the position

Closing the position:

  • Sell the Call and Put options.

Mitigation of losses:

  • Sell the position when there is one month left until expiry.

Example

Straddle strategy example

Straddle strategy example

ABCD is traded for $25.37 on 17. 05. 2017. The investor buys a Long Put option which has a strike price of $25.00, expires in August 2017. and costs $1.70 (premium). Then, buys a Long Call option which has a strike price of $25.00, expires in August 2017. and costs $2.40 (premium).

Price of the underlying (share price): S= $25.37
Premium (Long Put): P= $1.70
Premium (Long Call): C= $2.40
Strike price (Long Put): KP= $25.00
Strike price (Long Call): KC= $25.00
Net debit: ND
Maximum loss: R
Maximum profit: Pr
Lower breakeven point: LBEP
Upper breakeven point: UBEP

Net debit: ND = P + C
Maximum loss (risk): R = ND
Maximum profit: Unlimited
Lower breakeven point: LBEP = K - ND, where K = KP = KC
Upper breakeven point: UBEP = K + ND

ND = $4.10
R = $4.10
Pr = unlimited
LBEP = $20.90
UBEP = $29.10