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A straddle strategy is an approach in trading where you buy a put option and a call option together for the same stock, at the same price and expiry date.
But why do traders buy both options on the same stock? Let’s have a look at what is meant by a straddle strategy and how it is beneficial.
What is a straddle strategy?
Straddle strategy is a method to manage risk. The term “straddle” implies covering or spreading out, often used to talk about spreading bets, risks, values or ideas.
In the financial world, straddle strategy refers to two separate transactions involving the same security, where both transactions balance each other out. It’s used by investors when they expect a big change in a stock’s price but are uncertain whether the price will rise or fall.
A straddle strategy indicates the security’s expected volatility and shows the stock’s anticipated trading range on the expiration date.
Why do you need a straddle?
Market rates can shift a lot and fast sometimes. That’s why having a “straddle” is good for your investments. This plan involves buying call options at a fixed rate and put options at another rate. This way, you’ll make money no matter where the market goes.
Buy at the market rate for the best results when making a straddle. This will get you the most money with the least risk. Once the market hits the rate of your options, you make your profit. Always check the market and keep your plans fresh to earn the most and risk the least.
What is a long straddle?
A long straddle means buying both a call option and a put option at the same rate and expiry date. Depending on where you think the stock rate will go, it can be done for a net credit, a net debit, or a limited risk debit. This plan aims to make money from a big change in the stock rate.
Advantages and disadvantages of straddle positions
- Straddle positions make money whether the stock price goes up or down. If the price increases, you make a profit on the call option. If it decreases, you make a profit on the put option.
- Holding a straddle helps in mitigating risks as traders are covered for the stock’s movement in either direction.
- Straddle positions are profitable only if the stock’s price movement is higher than the premium paid. Else, it leads to a loss.
- One option will remain unused, leading to a loss of the premium paid for that option.
- Straddle positions are unsuitable in a stable market.
Profits in straddle strategy – how is it achieved?
A straddle strategy involves buying a call and a put option on a stock, both with the same expiry date. The call has a strike price above the stock’s current market price, and the put has a strike price below it.
This setup is like a “long synthetic option,” as mentioned. The idea is to make money whether the stock price goes up or down.
To earn profits, first, you get a call option, which means a chance to buy the stock later at a set price. This price should be more than the stock’s current price. Second, you get a put option, giving you a chance to sell the stock later at a set price, which should be less than the stock’s current price.
For instance, suppose a stock is at ₹100 now. You buy a call option at ₹110 and a put option at ₹90. If the stock price jumps to ₹120, your call option lets you buy at ₹110, making a ₹10 profit per share. If the stock falls to ₹80, your put option lets you sell at ₹90, again making a ₹10 profit per share.
This strategy needs good calculation. If done right, you can earn money regardless of the stock price movement.
The Straddle strategy in options trading is useful in any market, offering unlimited profit potential with limited risk. It remains neutral to market trends, suitable for both short and long-term use.
By buying a call and a put option on the same stock with the same expiry, traders can earn irrespective of market direction, making it a simple strategy for uncertain market scenarios.
– To work out the cost of a straddle, you need to add the prices of the put and the call options together. So, add the premiums of both options.
– Calculate the percentage of the premium against the strike price. (Premium/Strike price * 100).
– The price movement of the stock must be greater than this percentage, in either direction for a straddle to be profitable.
The current share price of ABC Ltd is ₹4,000. The company will announce its financial results in 3 days. So, the share price may either increase or decrease.
– So, you enter a straddle and buy a call and put option with strike prices of ₹4,000 each, expiring after 10 days.
– The premium on each option is ₹180, making the total premium ₹360.
– So, if the stock increases by more than 9% (360/4000 * 100 = 9%), you use your call option.
– If the stock price decreases by more than 9%, you use your put option.
While a straddle involves two options at the same strike price and expiration date, a strangle involves one call and one put on the same expiration date at different strike prices. A straddle helps when the trader is slightly confident about the direction of price movement but wants to cover other possibilities, too.
A straddle is neither bullish nor bearish. It is where traders are unable to ascertain the direction of stock’s prices because of which they buy both calls and put options to mitigate the risk.
A long straddle is where traders buy both calls and put options at the same strike price and expiration date. A short straddle is where traders sell both call and put options at the same price and expiration date. A short straddle usually limits the reward but exposes traders to a higher degree of risk.