The straddle option is a neutral trading strategy wherein you purchase both a call and a put option on the same underlying stock with an identical expiration date and strike price. To better understand the straddle, you need to know more about a call option and a put option.
AÂ call option refers to a contract between a buyer and seller wherein a security is set to be exchanged at a set price. In contrast, a put option is a contract that allows the owner to sell a certain amount of a specific security at a certain price within a set timeframe. Ultimately, the straddle option gives you the opportunity to reach an unlimited amount of profit when the stock moves sharply enough.
Long Straddle
A long straddle refers to the purchase of both a long call and a long put following the straddle strategy. The goal of this options strategy is to gain a profit from large, unpredictable moves. It works under the assumption that the underlying asset will move significantly in price, whether higher or lower.
Oftentimes, traders use this strategy before a news report because it can indicate that trading is uncertain and in small ranges. This leads the underlying asset to move quickly, regardless of the direction. Ultimately, a long straddle is a wise strategy that can help you profit no matter what happens. However, in the event the market doesn’t react strongly enough, the long straddle may not create the outcome you’d hoped for. Aim to use the long straddle when you expect a stock’s price to be volatile.
Short Straddle
Whereas you can profit from a significant move in either direction with the underlying asset’s price using the long straddle, the short straddle provides yet another opportunity for profit. When you use the short straddle, you can gain a profit when the price remains more or less constant.
To use this strategy effectively, determine the point in time when you think the underlying security’s price won’t increase or decrease too much. This allows investors to make a profit with no movement in the security’s price. The most you can make when you use the short straddle is how much profit you rendered from the premiums when you sold the options. In contrast, the potential maximum loss is unlimited. Aim to use the short straddle when you expect the stock’s price to remain neutral.
Now that you understand the straddle option, it’s easier to put this trading strategy to good use. Both the long straddle and short straddle strategies are effective ways to gain a profit when used successfully.
