Long Straddle Options Strategy

Submitted by admin on Thu, 11/25/2021 - 23:18

This approach entails purchasing both call and put options with the same strike price and expiration date.


A long straddle is formed by purchasing both a call and a put option with the same strike price and expiration date.
They combine to create a position that should profit if the stock makes a significant move in either direction.


Typically, investors purchase the straddle in anticipation of a large price move and/or significant volatility in the near future.
For instance, the investor may be anticipating a significant court judgement in the coming quarter, the outcome of which will be either extremely positive or extremely negative for the company.

Outlook


During the life of the options, we are looking for a dramatic move in the stock price, in either direction.
Due to the influence of two premium outlays on the breakeven point, the investor's position is quite firm and time-specific.

Summary


This approach entails purchasing both call and put options with the same strike price and expiration date.
Generally, the combination gains if the stock price rises sharply in either direction during the option's tenure.

 

EXAMPLE

  • Long 1 AAPL 150 call
  • Long 1 AAPL 150 put

 

GAIN MAXIMUM


Unlimited


LOSSES ARE LIMITED TO THE MAXIMUM


Paid premiums


Motivation


The long straddle is a strategy for profiting from greater volatility or a sudden movement in the price of the underlying stock.

Variations


A long straddle is constructed on the assumption that both the call and put options have the same strike price.
A long strangle is a variant on the same strategy, except that the call strike is higher and the put strike is lower.

Maximum Loss


The maximum loss is restricted to the amount paid for the two premiums.
The worst-case scenario is for the stock price to remain stable while implied volatility declines.
If the stock's price is exactly at the strike price at expiry, both options expire worthless, and the full premium paid to enter the position is lost.

Maximum Gain


Gains are limitless.
The best-case scenario is if the stock makes a significant move in either way.
At expiry, the profit is calculated as the difference between the current price of the stock and the strike price, less the premium paid for both options.
Profitability on the upside is unlimited, while profitability on the downside is limited only by the stock's inability to go below zero.

Profit/Loss


The greatest profit potential is limitless on the upside and quite large on the downside.
Gains on one of the two options can provide a sizable profit if the stock makes a sufficiently significant move, regardless of direction.
Furthermore, regardless of whether the underlying stock moves, a rise in implied volatility has the ability to boost the resale value of both options, achieving the same objective.


The maximum loss is the premium paid to open the position.
While the premium is restricted, it is not necessarily low.
Because the straddle strategy involves premiums on two distinct types of options rather than one, the total expenditure creates a relatively high barrier to profitability.

Breakeven


This approach is profitable if the stock price is either above or below the strike price by the premium paid at expiration.
At either of those levels, the intrinsic value of one option will match the premium paid for both options, while the other will expire worthless.


Breakeven point on the upside equals strike plus premiums paid


Breakeven point on the downside = strike - premiums paid

Volatility


Extremely critical.
The effectiveness of this technique would be facilitated by a rise in implied volatility.
Even if the stock remained unchanged, a sharp increase in implied volatility would tend to increase the value of both options.
This may theoretically allow the investor to profitably close out the straddle far in advance of expiration.


On the other hand, if implied volatility decreases, both options' resale prices decrease (and therefore, profitability).

Time Deterioration


Extremely detrimental consequence.
Because this strategy entails holding both a call and a put, both of which are at-the-money at the outset, each day that passes without a change in the stock's price results in a large erosion of the overall premium of this position.
Additionally, all other factors being equal, the rate of time decay can be predicted to accelerate near the strategy's last weeks and days.

Assignment Danger


None.
The investor retains complete control.

Risk of Expiration


If the options be held until they expire, one of them may be automatically exercised.
The investor should be aware of the exercise requirements, which require exercise to occur only when the intrinsic value of the option surpasses an acceptable minimum.


This technique may be viewed as a competition between time decay and volatility.
The passage of time gradually erodes the position's value, sometimes at an accelerated rate.
The anticipated rise in volatility might occur at any time or may never occur at all.