Creating an options contract that results in profit is crucial to profit from a derivative market. The straddle option strategy is one of the most popular trading strategies in the derivative market. It involves purchasing or selling both the call option and put option simultaneously using this same strike price and expiration day for any underlying asset. Let's understand this straddle strategy in options trading in detail and learn how to use the best options strategy for trading.
The straddle options trading strategy is one of the least sophisticated strategies. With minimal hassle, investors can take advantage of the market-neutral objective. To activate this strategy, you must create the purchase or sale of one call and one put option. The highlight of the strategy is creating an equal number of puts and calls with the same strike price and expiration date. The two types of straddle positions are:
Here is a table that compares the two straddle option strategies:
Feature |
Long Straddle |
Short Straddle |
Definition |
Involves the simultaneous purchase of a call and a put option on the same underlying asset with the same expiration date and strike price. |
Involves the simultaneous sale of a call and a put option on the same underlying asset with the same expiration date and strike price. |
Strategy |
Profit from large price movements in either direction. |
Profit from low volatility and limited price movement. |
Working |
The investor buys a call option to profit if the underlying asset's price rises and a put option to profit if the price falls. |
The investor sells a call option, obligating him to sell the underlying asset at the strike price if exercised, and sells a put option, obligating them to buy the underlying asset at the strike price. |
Profit Potential |
Unlimited if the underlying asset's price moves significantly in either direction. |
Maximum profit is limited to the premium received from selling both options. |
Loss Potential |
Limited to the premium paid for both options. |
Unlimited if the underlying asset's price moves significantly in either direction. |
Risk Profile |
High risk, high reward. |
Low risk, low reward. |
Market Conditions |
Best suited for high volatility and uncertain market direction. |
Best suited for low volatility and expected price stability. |
Break-even Points |
Strike price +/- premium paid for both options. |
Strike price +/- premium received from selling both options. |
Maximum Profit |
Unlimited |
Premium received |
Maximum Loss |
Premium paid |
Unlimited |
Suitable for |
Investors expecting high volatility and uncertain market direction. |
Experienced traders confident in low volatility and expecting limited price movement. |
The call and put options are placed based on the type of straddle strategy.
With long straddle positions, two options are available:
The trader can hedge his bets by purchasing both options. This generates profit when the market moves significantly in either direction, extending beyond the break-even points. So, this strategy will enable you to profit from both market increases and declines. However, you may incur a loss when the market price movement does not surpass the break-even point.
The short straddle strategy is the direct opposite of the long straddle strategy. It is suitable when there is depressed market volatility. It can also be used when sideways movement is expected in the underlying asset. The trader sells both call and put options with the same price and expiration date. Profit is collected when the market price movement is insignificant.
Let's understand the straddle strategy with an example:
Assume stock ABC is trading at Rs. 100 per share. You believe there will be a significant price movement in ABC, but you're unsure of the direction.
Assume stock ABC is trading at Rs. 100 per share. You believe the price of ABC will remain relatively stable.
The right trading strategy depends on the uncertainty and volatility in the market regarding the price moment. The optimal condition for a long straddle is volatility, while for a short straddle, it is low volatility.
For a long-straddle strategy, the maximum profit is unlimited, and the maximum loss is limited to the total premium paid. However, for short straddle, the maximum profit is limited to the premiums received, and the maximum loss is theoretically unlimited. Before choosing the right strategy, traders should carefully consider these risk factors. Adequate risk management techniques are crucial to mitigate losses in the derivatives market.
The straddle option strategy involves buying or selling both call and put options simultaneously. The strike price and expiration date remain the same. The long straddle is ideal in a highly volatile market, and the short straddle is suitable when the market price is expected to be relatively stable. The straddle strategy's profit and loss potential depends on the market's volatility. As it is impossible to predict market volatility accurately, traders should be cautious while implementing these options trading strategies.