What are Straddle Options?
A straddle option is a trading strategy in which the trader simultaneously buys both a call and put option at the same strike price and expiration date for an underlying asset. A straddle option is a useful when the trader believes the price an underlying asset or contract will move, but not sharply. They want the price to rise or fall an amount that is greater than the total premium they paid.
How do Straddle Options Work?
The best way to explain how a straddle option works is to give a hypothetical example. Let’s say the price of Asset A is currently trading at $50 and the trader thinks the asset will move, but only slightly, the trader may want to create a straddle. In order to do that they would purchase both a call and a put option at that $50 strike price, thus creating their straddle. Let’s say the premium for purchasing the put and the call are $3 each, giving us a total premium paid of $6. We have now created a trading range of $44-$56 for Asset A.
Now to turn a profit, the trader would want a move that is greater than the total premium paid. Let’s say the price dropped to $40. The trader would lose the $6 premium on the call option, but make $10 on the put option, giving them a profit of $4. Now obviously this is just an example and real-world assets don’t move as cleanly as this, but you get the idea. In order to turn a profit the trader needs a move that is equal or greater than the total premium paid.
Difference Between Long and Short Straddle Options
Straddle options come in two different forms, a long straddle, and a short straddle. They both follow the same principle that a trader must be holding a call and a put option on an underlying asset at the same strike price and same expiration date, but they then differ from there.
Long Straddle Option
A long straddle option occurs when a trader purchases both a call and put option for an underlying asset at the same strike price and same expiration date. The strike price in question is as close to at-the-money as possible. A trader will use a long straddle option when they believe the volatility of the underlying asset will from relatively low to relatively high. A long straddle position aims to take advantage of a move up or down. If the price continues to move up, the profit potential is unlimited. If for some reason the price of the asset hits zero then the profit would be the strike price, minus the total premium paid. Either way, the maximum risk for a trader is the total premium paid.
Short Straddle Option
A short straddle option occurs when a trader sells a put and call option for an underlying asset at the same strike price and same expiration date. In a short straddle option, a trader aims to profit on a small move or no move at all in an underlying assets market price. This scenario allows the trader to profit when the price movement of an asset remain neutral and/or close to neutral. This is a riskier strategy because the maximum profit is the total premium gained by selling the options. The maximum loss is theoretically unlimited if the asset makes a large move up.
Straddle vs. Strangle Options
Strangle and straddle options are both similar in that they are an options strategy where the investor purchases an equal amount of call and put options and aims to profit from a major move in the assets underlying current market price. However, the difference between the two is that in a
strangle option the call and put options have different strike prices, while in a straddle option the strike prices of the call and put option are the same. For a more detailed breakdown of strangle options, be sure to visit our strangle options page.