Learn how to profit in both up and down directions with the Long Straddle
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Long Straddle - Introduction
The Long Straddle or simply a Straddle, is a volatile option strategy that profits no matter if the underlying asset goes up or down.
Yes, a Long Straddle is best used when you expect a stock to stage a breakout to either upside or downside very quickly. Conditions that
typically lead to such uncertain breakouts are pending court verdicts or drug approvals.
A Long Straddle works based on the premise that both call and put options have unlimited profit potential but limited loss. While
of the Long Straddle losses up to its limit,
the other leg continues to gain as long as the underlying stock rises, resulting
in an overall profit.
Straddles, Strangles and Long Guts form the family of basic volatile options strategies and each have their own pros and cons. Here's a comparison table:
Cost of Position
The straddle can also be given a bullish inclination through creating a Strap Straddle
or a bearish inclination through creating a
When To Use Long Straddle?
One should use a long straddle when one is confident of a move in the underlying asset but is uncertain as to which direction it may be. Situations that creates an uncertainty as to the direction of move may be
just before an important corporate announcement, court verdict, earnings announcement etc... (read about the problem with earnings straddle
How To Use Long Straddle?
Establishing a long straddle simply involves the simultaneous purchase of an at the money
A call option allows you unlimited profit to upside and limited loss to down side and a put option allows you unlimited profit to downside and limited loss to upside.
Combine them both and you will have a long straddle which profits in both up and down market. If you are already holding a long
or short stock position,
you could establish a Straddle synthetically through the use of a Synthetic Straddle
without closing your existing stock position.
Buy ATM Call + Buy ATM Put
Long Straddle Example
Assuming QQQQ at $44. Buy To Open QQQQ Jan44Call, buy To Open QQQQ Jan44Put
Problems With Executing Long Straddle
The problem with the Long Straddle is that you can rarely ever get exactly at the money options. As such, strike price is usually chosen as close to the money as possible. However, the problem with using a straddle that is not exactly at the money is that the overall delta
of the position will be skewed to either slightly bullish or slightly bearish inclined. If the strike price used is higher than the price of the stock, the put options would be in the money with higher delta value than the call options, resulting in a negative delta position which gains to downside and loses to upside as the price of the stock moves before expiration. If the strike price used is lower than the price of the stock, the call options would be in the money with higher delta value than the put options, resulting in a positive delta position which gains to upside and loses to downside for the short term.
However, this is not a concern if you intend to hold the Long Straddle position all the way to expiration. If you hold it all the way to expiration, the position will profit as long as the price of the underlying stock exceeds the upper or lower breakeven point.
Long straddles can also be very unprofitable when put on just before an earnings release. This is known as an "Earnings Straddle". Read about the Problems with Earnings Straddle
Trading Level Required For Long Straddle
A Level 2 options trading account that allows the buying of both call options and put options is needed for the Long Straddle. Read more about Options Account Trading Levels
Profit Potential of Long Straddle
Long Straddle profits in 3 ways. Firstly, if the stock goes up, the long call option goes up in price along with the stock price while the long put option expires out of the money.
Secondly, if the stock goes down, the long put option goes up in price along with the drop in the stock price while the long call option expires out of the money.
In this respect, the maximum profit for this strategy is the amount gained/dropped in the underlying asset less the premium
decay of the in the money option, less the price paid for the out of the money option.
The third way the Long Straddle could turn a profit is when the implied volatility
of the underlying stock increases, increasing the extrinsic value
of both options involved in the position, even if the price of the underlying stock remained stagnant.
Profit Calculation of Long Straddle
% Return = [Exit Price of Underlying Asset - (Strike Price + Net debit)*] ÷ Net Debit
* : If the underlying asset is down, use (Strike Price - Net debit)
|Following up on the above example, assuming QQQQ at $50 at expiration.
Bought the JAN 44 Call for $2.20
Bought the JAN 44 Put for $2.00
% Return = [50 - (44 + 4.20)] ÷ 4.20 = 43% profit
Max. Risk = Net Debit = $4.20, if stock remains at $44
Upper Break Even = Strike Price + Net Debit = $44.00 + $4.20 = $48.20
Lower Break Even = Strike Price - Net Debit = $44.00 - $4.20 = $39.80
Risk / Reward of Long Straddle
Maximum Profit: UnLimited
Technically, the most the Long Straddle can make to downside is limited to how much the stock can drop, which is limited to a price of $0. In options trading, we label as unlimited profit when an options strategy gains as long as the underlying stock moves.
Maximum Loss: Limited
Net Debit Paid
Break Even Point of Long Straddle
There are 2 break even points to a long straddle. One breakeven point if the underlying asset goes up (Upper Breakeven), and one breakeven
point if the underlying asset goes down (Lower Breakeven).
Upper BEP: Strike Price + Net Debit Paid
Lower BEP: Strike Price - Net Debit Paid
Long Straddle Greeks
Delta : Neutral
Delta of Long Straddle is neutral when the strike price is exactly at the money with the delta value of call options at 0.5 and put options at -0.5, neutralizing each other, resulting in no win or lose when the stock make small moves in either direction.
Gamma : Positive
of Long Straddle is positive and will therefore increase the delta value in the direction of the stock move. If the stock moves upwards, the delta value of the Long Straddle will move away from neutrality to become increasingly positive and if the stock moves downwards, the delta value of the Long Straddle will become increasingly negative. This allows the Long Straddle to profit in either direction.
Theta : Negative
of Long Straddle is negative and will therefore lose value over time due to time decay
Vega : Positive
of Long Straddle is positive and will therefore gain value as implied volatility rises and loses value as implied volatility drops. As such, it is highly disadvantageous to use a Long Straddle in periods of high implied volatility as a volatility crunch
could wipe out all possible profits and more.
Advantages Of Long Straddle
:: Able to profit no matter if the underlying asset goes up or down.
:: Unlimited profit if the underlying asset continues to move in one direction.
:: Saves time from having to analyse if a stock will go up or down ahead of major news releases.
:: Loss is limited to the debit paid.
:: If volatility is low at the time of purchase and volatility rises, both options could profit even without an appreciable change in the stock price.
Disadvantages Of Long Straddle
:: There will be more commissions involved than simply buying call or put options.
:: You can lose more money if the underlying asset stayed stagnant than if you simply bought a call or put option.
:: If the underlying asset rises above the strike price or falls below the strike price but remains below the upper break even or above the lower break even you will still incur a loss on the position.
:: If volatility falls for both or either option, the position could lose with or without a price swing in the underlying asset.
Adjustments for Straddles Before Expiration
If the underlying asset has moved beyond its breakeven point and is expected to continue to move strongly in the same direction,
one could sell the out of the money option so that some value is recovered from it.
If one is very aggressive and confident that the underlying asset will continue to move strongly in the same direction, one could
then use the money gained from selling the out of the money option, and buying more contracts of the in the money option.
Long Straddle Related Questions...
:: Combining Covered Call with Straddle?