Long Straddle

Long Straddle

Post By - Laxmi Mahera
Review By : Rohan Sharma
Updated on : October 26, 2021

Basics Concepts – Long Straddle

Description - Straddle

The Straddle is the most popular volatility strategy and the easiest to understand.
We simply buy puts and calls with the same strike price and expiration date so that we can profit from a stock soaring up or plummeting down
Each leg of the trade has limited downside (i.e., the call or put premium) but uncapped upside.
Assuming that the movement of the stock is enough to cover the cost of the trade, we should be profitable.
The cheaper the cost of the Straddle, the better, provided that the stock is one that can and will move explosively
Buy ATM strike puts, preferably months to expiration.
Buy ATM strike calls with the same expiration.

Introduction to Long Straddle

Outlook

With straddles, your outlook is direction neutral. You are looking for increasing volatility with the stock price moving explosively in either direction.

Rationale

To execute a neutral trade for a capital gain while expecting a surge in volatility.
Ideally you are looking for a scenario where Implied Volatility is currently very low, giving you low option prices, but the stock is about to make an explosive move—you just don’t know which direction.

Net Position

This is a net debit transaction because you have bought calls and puts.
Your maximum risk on the trade itself is limited to the net debit of the bought calls and puts. Your maximum reward is potentially unlimited.

Effect of Time Decay

Time decay is harmful to the Straddle. Never keep a Straddle into the last month to expiration because this is when time decay accelerates the fastest.

Time Period to Trade

We want to combine safety with prudence on cost. Therefore the optimum time period to trade straddles

Breakeven Down = [Strike – net debit]

Breakeven Up = [Strike – net debit]

Steps to Trading a Long Straddle

Steps In

Actively seek chart patterns that appear like pennant formations, signifying a consolidating price pattern.
Try to concentrate on stocks with news events and earnings reports about to happen within two weeks.
Choose a stock price range you feel comfortable with.

Steps Out

Manage your position according to the rules defined in your Trading Plan.
Exit either a few days after the news event occurs where there is no movement, or after the news event where there has been profitable movement.
If the stock thrusts up, sell the call (making a profit for the entire position) and wait for a retracement to profit from the put.
If the stock thrusts down, sell the put (making a profit for the entire position) and wait for a retracement to profit from the call.
Try to avoid holding into the last month; otherwise, you’ll be exposed to serious time decay.

Exiting the trade - Long Straddle

Exiting the Position

With this strategy, you can simply unravel the spread by selling your calls and puts.
You can also exit only your profitable leg of the trade and hope that the stock retraces to favor the unprofitable side later on.

Mitigating a Loss

Sell the position if you have only one month left to expiration. Do not hold on, hoping for the best, because you risk losing your entire stake.

Advantages and Disadvantages

Advantages

Profit from a volatile stock moving in either direction.
Capped risk.
Uncapped profit potential if the stock moves.

Disadvantages

Expensive—you have to buy the ATM call and put.
Significant movement of the stock and option prices is required to make a profit.
Bid/Ask Spread can adversely affect the quality of the trade.
Psychologically demanding strategy

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