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Long Straddle (or Buy Straddle)
The long straddle, also known as buy straddle or simply "straddle", is a neutral strategy in options trading that involve the simultaneously buying of a put and a call of the same underlying stock, striking price and expiration date.
| Long Straddle Construction |
| Buy 1 ATM Call Buy 1 ATM Put |
Long straddles are unlimited profit, limited risk options trading strategies that are used when the options trader thinks that the underlying securities will experience significant volatility in the near term.
Unlimited Profit Potential
Large profit is attainable with the long straddle when the underlying stock price makes a strong move either upwards or downwards at expiration.
The formula for calculating profit is given below:
- Maximum Profit = Unlimited
- Profit Achieved When Price of Underlying > Strike Price of Long Call + Net Premium Paid OR Price of Underlying < Strike Price of Long Put - Net Premium Paid
- Profit = Price of Underlying - Strike Price of Long Call - Net Premium Paid OR Strike Price of Long Put - Price of Underlying - Net Premium Paid
Limited Risk
Maximum loss for the long straddle occurs when the underlying stock price on expiration date is trading at the strike price of the options bought. At this price, both options expire worthless and the options trader loses the entire initial debit taken to enter the trade.
The formula for calculating maximum loss is given below:
- Max Loss = Net Premium Paid + Commissions Paid
- Max Loss Occurs When Price of Underlying = Strike Price of Long Call/Put
Breakeven Point(s)
There are 2 break-even points for the long straddle. The breakeven points can be calculated using the following formulae.
- Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid
- Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid
Example
Suppose XYZ stock is trading at $40 in June. An options trader enters a long straddle by buying a JUL 40 put for $200 and a JUL 40 call for $200. The net debit taken to enter the trade is $400, which is also his maximum possible loss.
If XYZ stock is trading at $50 on expiration in July, the JUL 40 put will expire worthless but the JUL 40 call expires in the money and has an intrinsic value of $1000. Subtracting the initial debit of $400, the long straddle trader's profit comes to $600.
On expiration in July, if XYZ stock is still trading at $40, both the JUL 40 put and the JUL 40 call expire worthless and the long straddle trader suffers a maximum loss which is equal to the initial debit of $400 taken to enter the trade.
Short Straddle
The converse strategy to the long straddle is the short straddle. Short straddles are used when little movement is expected of the underlying stock price.
Modified Straddles
There are two modifications of the straddle strategy, the strap and the strip, which can be implemented to introduce a bullish or bearish bias to the risk/reward curve.