Long Straddle Explained



Intermediate traders can choose to use the long straddle options strategies. These strategies may seem complicated at first, but put simply involve buying a put and a call for the same stock, price and expiration date at the same time.

It is possible to use this strategy when you believe that the assets will experience a lot of volatility during the relative short term.

Buy 1 At The Money (ATM) Call

Buy 1 At The Money (ATM) Put

long straddle

Maximum Profiting

Traders can earn large profits by having open long positions in both call and put options. This means that these traders can profit whether the stock moves up or down.

The profit can be calculated easily by using the following equation:

Profit = Price of Underlying – Strike Price of Long Call – Net Premium Paid

OR

Strike Price of Long Put – Price of Underlying – Net Premium Paid

Maximum Losses

As with all trades, it is possible to lose money as well as make it. If the stock price is at the current strike price, in this instance both of the option contracts placed will expire worthless, this means that you will lose the premium you paid to enter the trade.

To calculate the maximum loss, use the following formula:

Maximum Loss = Net Premium Paid + Commissions Paid

The maximum loss happens when the price of the asset is equal to the strike price of the long call or put.

Breakeven Point

When using the long straddle strategy you will experience two breakeven points, these are where you will make nothing, but also loose nothing.

It is possible to work out the point of these breakeven points by using the following calculations:

Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid

Lower Breakeven Point = Strike Price of Long Put – Net Premium Paid

Worked Example

Let us suppose that Apple stock is currently trading at $40 at the start of May. It is possible to enter a long straddle, to do this buy a Jun 40 put for $200 and an extra JUN 40 call for the same asset. Both of these options cost $200, which means the debit taken to enter the long straddle is $400.

At the expiration date, if the Apple stock is $50 then the put option will be worthless, and the call will expire in the money. This call option will have an intrinsic value of $1000. When you take off the initial cost of $400 to enter the trade, the profit will be $600.

If Apple stocks are currently at $40 then both of the options will be worthless on expiry. This will mean that you will lose the most amount of money possible, which in the case of the example is $400, the amount of money paid to enter the trade.

Commission

Just to make the example as easy to understand as possible, we have missed out the commission that you would need to pay. You will always need to pay a broker for all trades. These commission payments are generally between $10 and $20.

While the commission payments aren’t too expensive, if you trade regularly then these commission payments can really mount up. It is possible to find frequent trader brokers which offer discounts for traders which use their accounts regularly. OptionsHouse.com has very low commissions for frequent traders.

Conclusion

Long Straddle Options trading strategies are fairly easy to understand. Once you have mastered placing long call options, you should consider learning more about the long straddle.

It is possible to profit from this strategy when the market is volatile. As the strategy has limited losses and unlimited profits, it is a very popular trading strategy to consider using.




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