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Long Straddle

Updated on April 4, 2024
Article byRutan Bhattacharyya
Edited byRutan Bhattacharyya
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Long Straddle?

A long straddle is an options trading strategy that involves the simultaneous buying and selling of a long and a put on a particular underlying security, with both options having the same expiration date and strike price. One uses it to profit from a significant price movement (in either direction).

Long Straddle

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Source: Long Straddle (wallstreetmojo.com)

Usually, traders opt for this strategy when they expect the underlying financial instrument to be subject to increased volatility in the near term. Newsworthy events, such as regulatory approvals or an earnings release, may trigger such volatility, thus enabling traders to make a profit. In theory, individuals can make financial gains as security prices do not have a maximum limit.

Key Takeaways

  • Long straddle meaning implies an options trading strategy in which traders buy a put and a call for a particular underlying security, with both contracts having the same expiration debt and strike price.
  • Typically, traders opt for this strategy when they think a forthcoming newsworthy event, such as an earnings release, will increase the volatility of a financial instrument.
  • A key difference between short and long straddles is that the latter has unlimited profit potential.
  • An inherent risk of this options trading strategy is that the market participants might not react strongly enough to the upcoming event.
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How Does A Long Straddle Option Strategy Work?

Long straddle meaning refers to an options trading strategy involving a combination of a long and a put with the same strike price and expiration date on a specific underlying financial asset. This strategy enables traders to profit from an increase in volatility and a significant movement, either up or down, in the underlying financial instrument’s price.

In other words, a trader using this strategy bets on the underlying security’s price to rise or fall significantly in either direction. Usually, individuals choose this strategy when they think that the volatility associated with underlying asset will increase or decrease owing to the impending release of some new information. Hence, traders usually utilize this strategy before the result of an election, an earnings release, or any other newsworthy event that can significantly influence the price of the underlying financial asset.

When traders are not aware of the outcome of the actual event, they try to decide whether to be bullish or bearish. In such a scenario, opting for the long straddle strategy can be wise. Theoretically speaking, the profit potential in the case of this strategy is unlimited to the upside. In contrast, one can earn limited profits on the downside as the financial instrument’s price can drop to only 0.

That said, one must be aware of the risks associated with this options trading strategy. For instance, the possibility that the market’s reaction to the result of the newsworthy event might not be sufficiently strong. Moreover, the fact that the options sellers know that such an event is impending increases the prices of put and call options. Thus, the cost of using this trading strategy is more than placing a bet on the direction of price movement only. Additionally, if any newsworthy event is not imminent, implementing this strategy will be more expensive than placing a bet in both directions.

If the upcoming event does not trigger a strong upward or downward price movement, the options bought by a trader might expire worthlessly. As a result, the trader might suffer significant losses.

Graph

Let us look at this example below to understand the long straddle graph.

Suppose a trader purchases a straddle for $20 at the strike price of $120 for a stock trading at $120. The stock’s price must be above $130 or below $110 on or before the expiration of the two options contracts for the trader to make financial gains.

Long Straddle Graph

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As one can observe, this diagram is V-shaped. Technically, the profit potential is unlimited to the upside for traders using this strategy.

Individuals can use this formula to compute their profit when the underlying financial asset’s price increases:

Profit (when the price increases) = The underlying financial asset’s price – net premium paid – the call option’s strike price.

Individuals must use the following formula to calculate their profit if the price moves downward:

Profit (when the price decreases) = The put option’s strike price – the underlying asset’s price – net premium paid

The break-even point for a trade is the overall cost of put and call options above/below the strike price. To calculate the maximum loss, one has to compute the sum of the total premium paid and the trade commissions. Such a loss occurs when the underlying security’s price equals the options contracts’ strike price at expiration.

Example

Let us look at this long straddle example to understand the concept better.

Suppose XYZ stock is trading at $50. John, a trader, decides to use the long straddle strategy. He buys a long and a call option on the stock at a strike price of $100. The call costs $22, while the put costs $20. Hence, the overall cost borne by John is $22 + $20, i.e., $42. If the strategy fails, John’s maximum loss will be $42. On the expiration date, XYZ stock trades at $150.

The put option instantly expires as it is out of the money or OTM. That said, the put option on the stock is in the money as the strike price is less than the underlying asset’s trading price. When the contract expires, his earnings from the option will be $50 ($150 – $100). After subtracting the initial cost ($42), John will get a profit of $8 ($50-$42).

Short Straddle vs Long Straddle

Short and long straddle are useful strategies for options traders aiming to make financial gains. However, knowing the key differences between these two strategies is crucial for individuals to decide which is best suited to them. Hence, this table highlights some distinct characteristics of both these strategies. One can go through them to get a clear idea regarding the two concepts.

Short StraddleLong Straddle
Traders using this strategy simultaneously sell a call and a put with the exact expiration date and strike price on a specific stock or any other security. The traders purchase one call and one put with an exact expiration date and strike price on the same security. 
The risk is unlimited. The risk is limited.  
Traders bet the underlying asset’s price will be relatively stable. Traders bet the underlying financial instrument’s price to be highly volatile. 
The unlimited profit potential is a noteworthy feature of this strategy.This strategy offers limited profit potential. 

Frequently Asked Questions ( FAQs)

1. How to adjust long straddle?

Individuals can adjust a long straddle to a reverse iron butterfly. To do that, they must sell an option above the long call option and below the long put option. The credit resulting from this sale reduces the maximum loss. However, one must remember that the maximum profit is not more than the spread width minus the overall debt paid.

2. Is long straddle a good strategy?

Yes, this strategy can be useful for traders as they can earn substantial profits, especially on volatile financial assets. Even a medium price movement in the spot market can generate substantial returns for traders. Moreover, hedging with a put and a call minimizes the risk associated with a trade.

3. When to use long straddle strategy?

Typically, traders use this strategy when they think that a forthcoming newsworthy event, for example, the release of the annual budget, can trigger a significant movement in the underlying financial asset’s price.

4. How to exit a long straddle?

When the underlying asset’s price moves far enough in either direction before the expansion of the implied volatility or the expiration of the options contracts, traders can sell to close the contracts and exit their position.

This article has been a guide to What is Long Straddle and its meaning. Here, we explain it with a graph and an example and compare it with the long straddle. You may also find some useful articles here –

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