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Straddle Option Strategy

Straddle Option Strategy

What is Long Straddle Option Strategy?

  • Long Straddle Option Strategy is just opposite Short Straddle and is a Volatility Strategy that aims to make money wherein you do expect underlying to show any significant movement or expecting rise in volatility, i.e. a large price swing. Long option Straddle strategy demands underlying to move significantly i.e., this is non directional strategy. In other words, if the underlying shows a significant move and closes above or below bought strike, usually ATM, then the strategy will gain significantly.

When to Execute Long Straddle Option Strategy?

  • Long Straddle is a non-directional strategy, but trade must also be bullish on volatility. It is advised that long straddle should be implemented when there is an event in near term, and volatility is on the lower side and expected to increase or can be implemented on high Volatile underlying. Long Straddle generally Implemented before any major events, like Elections, Budget etc.

What is the Trade?

  • Under Long Straddle Option Strategy, 1 lot of At-the-Money (OTM) Call option and Put option, each, for the same underlying, same strike price and same expiry are bought.

Break-Even Point

  • Long Straddle will have 2 break-even points. The breakeven points can be calculated as given below. Lower Breakeven = ATM Strike Price - Net Premium Paid. Upper Breakeven = ATM Strike Price - Net Premium Paid. Net Premium paid, is actually the premium of both the call option and put option, as both the options are bought.

What will be maximum profit?

  • Maximum Profit is undefined, if market shows the significant move and stays above upper or lower breakeven.

What will be maximum loss?

  • It is a Net debit strategy as we have bought both Call option and Put option, Maximum loss is only at bought strike price i.e., ATM strike. If the underlying stays at the ATM strike, the maximum loss occurs.

What are the advantages?

  • Being Directionally Neutral, you can participate in either way volatility jumps. Ideal to trade Straddle for stocks where earnings are due to be announced. On Indices, where any major macro-economic data is due.

What are the disadvantages?

  • Time decay is harmful to Straddle. Time day accelerates exponentially on the last week of expiry.As Days To Expiry (DTE) decrease, there is an inherent jump in the theta decay factor and the options decay rapidly. The cost to establish a long option straddle is significantly high. If stock fails to give desired move, one can lose the premium, of both the legs.

Example of Long Straddle:

  • Nifty future fair price 2 Feb 2023 : 17918.
    Long Straddle can be devised by
    Buying one lot of 17900 PE at 159.25
    Buying one lot of 17900 CE at Rs.184.30.
    Net Premium Paid = Rs.343.55
    Expiry: 2 Feb 2023
    Undefined profit potential if stock moves above or below the upper or lower expiry breakeven i.e., 17556 and 18244.
    Max loss if underlying closes at 17900, i.e. Rs 343.55 *50 (lot size) = Rs 17,178/-

Impact of volatility change:

  • When volatility increases, long straddle option strategy, increases in price and makes money. When volatility falls, long straddles decrease in price and lose money. In the language of option trading, it is a positive vega option strategy.

Impact of Time value decay:

  • The time value component of an option's total price decays as Days to Expiry decrease. This is known as time decay or theta decay. Since long straddles consist of two long options, the sensitivity to time erosion is higher than for single-option positions. Long option straddles tend to lose money rapidly as time passes and the stock price does not fluctuate much. So, what one needs is, a sharp swing in the underlying stock/index at a rather rapid pace, swiftly.