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Options Strategy – Straddle


A Straddle is an options trading strategy that involves buying both a call option and a put option with the same strike price and expiration date on the same underlying asset. This strategy is typically used when a trader expects significant price volatility in the underlying asset but is unsure of the direction of the movement. The goal is to profit from a substantial price change, either up or down.

  • Market Direction: Range Breakout
  • Difficulty: Intermediate

How It Works

  1. Buy a Call Option: The trader buys a call option with a specific strike price.
  2. Buy a Put Option: The trader buys a put option with the same strike price and expiration date.
  3. Market Movement: The trader profits if the underlying asset’s price moves significantly in either direction.
  4. Profit and Loss: The maximum loss is limited to the total premiums paid for both options. The potential profit is unlimited on the upside for the call and substantial on the downside for the put.

Example of a Straddle Strategy

Let’s say you expect a major price movement in Company ABC, currently trading at $100, due to an upcoming earnings announcement, but you are unsure whether the movement will be up or down. You decide to implement a Straddle with the following specifics:

  • Buy Call Option: Strike Price $100, Premium Paid $5 per share
  • Buy Put Option: Strike Price $100, Premium Paid $5 per share
  • Expiration Date: 1 month from now

You trade one call option and one put option contract, each representing 100 shares. Your total investment (premium paid) is:

100 shares×($5+$5)=$1,000100 shares x ($5 + $5) = $1,000100 shares×($5+$5)=$1,000

Scenarios

  1. Stock Price Rises Significantly Above $100
    If, at expiration, the stock price rises to $120:
    • Call Option Profit: $120 (market price) – $100 (strike price) = $20 per share.
    • Put Option Loss: $5 (premium paid).
    • Net Profit: ($20 \times 100) – $1,000 (total premiums) = $2,000 – $1,000 = $1,000.
  2. Stock Price Falls Significantly Below $100
    If, at expiration, the stock price falls to $80:
    • Put Option Profit: $100 (strike price) – $80 (market price) = $20 per share.
    • Call Option Loss: $5 (premium paid).
    • Net Profit: ($20 \times 100) – $1,000 (total premiums) = $2,000 – $1,000 = $1,000.
  3. Stock Price Remains Near $100
    If, at expiration, the stock price remains at $100:
    • Both Options Expire Worthless: Total loss is the premiums paid.
    • Net Loss: $1,000 (total premiums).

Benefits of Straddle Strategy

  • Unlimited Profit Potential: Can profit significantly from large price movements in either direction.
  • Market Volatility: Ideal for situations where high volatility is expected.

Risks of Straddle Strategy

  • Limited to Premiums Paid: Maximum loss is limited to the total premiums paid for both options if the price remains stable.
  • High Cost: Requires a substantial initial investment in premiums.

The Straddle strategy is an effective way to profit from high market volatility when the direction of the price movement is uncertain.

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