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.
Buy 1 ATM Call, Buy 1 ATM Put
Long straddle options 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
By having long positions in both call and put options, straddles can achieve large profits no matter which way the underlying stock price heads, provided the move is strong enough.
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 long straddles 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.
Net Premium Paid + Commissions Paid
Loss occurs when: Price of Underlying = Strike Price of Long Call/Put
Breakeven points
Strike Price of Long Call + Net Premium Paid
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.
Commissions
These examples exclude commissions and fees. Include all transaction costs when evaluating the profit or loss of a position.
Similar strategies
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.