Option Straddle, or simply Straddle, is a popular investment strategy that allows the investor to profit from an option position by how to underlying’s price will move rather than the direction of the price. Regardless whether the price is moving up or down, the price must move significantly in order for an investor to profit, otherwise, the investor will incur a loss. However, there are some stocks that move significantly in a sudden instance but these stocks are placed at a premium, so investors will still incur a loss. In this options strategy, the investor has an open position with a call or a put option at the same strike price and expiration date.
There are two types of option straddles. The purchase of option derivatives is called Long Straddle. Selling of options derivatives is called a Short Straddle. We will explain and illustrate each one.
Going long refers to the purchase of both a call and put option of the same underlying, stock, interest rate or other derivatives. The two options are bought at the same strike price and same expiration date. If the price will move across the strike price – whether above or below – the investor will gain a profit.
When the price significantly moves up, the investor can use the call option. When the price significantly moves down, the investor can use the put option. This works when the market is volatile and there is significant movement of the price.
A Long Straddle has a huge and unlimited profit potential. The limited risk involved in this strategy is equal to the total of all the premiums paid by the investor for the options.
Short Straddles are the opposite of Long Straddles. It involves selling call and put options with the same underlying. It also is critical to sell at the same strike price and same expiration date. The profits that can be gained in this strategy are limited to the total premiums of the call and put options. However, there is unlimited risk that comes from how the underlying security moves up too high or down too low. So, compared to Long Straddles, a Short Straddle has limited profit potential and unlimited risk.
Long or Short Straddles are very profitable plays if nicely executed. As long as you stay in the range and take into acocunt the factors that will move the stock significantly. Also, know the amount of risk you’re willing to take and the level of profit you want to gain. Remember, it’s your money and only you can decide. To beat the market, you have to be an educated investor.
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