Long Straddle Option

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What is a Long Straddle?

Options straddles can be split into two different configurations, a long straddle and a short straddle. We’re going to run through the Long Straddle to explain what you will need to know if you wanted to run this strategy.

 

Long Straddle

A long straddle is a strategy in which you buy a call option and a put option, typically at the money, both with the same strike price and expiration. Together, they produce a position that will profit if the stock makes a big move either up or down.

This strategy works best in volatile markets with prices moving sharply in either direction. The best time to buy a long straddle is during quiet trading periods as you will pay less for the two options as their implied volatility will be lower; but with the expectation that more volatile trading conditions will happen in the future (for example due to an increase in geopolitical tensions).

By having long positions in both call and put options, straddles can achieve large profits no matter which way the underlying stock price heads, provided the move is strong enough. Given the way that the straddle is set up, only one of the options will have intrinsic value when it expires, but the investor hopes that the value of that option will be enough to earn a profit on the entire position. This employs unlimited profit with an allowance for limited risk.

 

Graph showing a long straddle with strike price and break even

Long Straddle Example

Let’s look at an example of buying straddle options in XYZ Plc with a strike price of 400 and paying a total of 53 in premium for the two options. The worst-case scenario here is if the stock doesn’t move and remains at 400 on expiry meaning the options expire worthless and you lose the 53 per that you paid for the strategy.

On the other hand, if the stock moves sharply in either direction to say, 290 or 510 then you will make a profit of 57 (if the market is at 290) or 57 (if the market is at 510)

 

Long Straddle Summary

CONFIGURATION:

  • Buy a put with a strike price (typically at the money)
  • Buy a call with the same strike price as the put
  • Both options must have the same expiry date

OUTLOOK:

  • Anticipates high volatility – You think a move is coming but are not sure which way (strategy employed before earnings statement etc)

TARGET:

  •  Underlying price moves strongly in either direction

PROS:

  • Defined risk strategy
  • Can benefit from a strong move in either direction

CONS:

  • High time decay in a neutral market
  • Premiums can be very high

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