Straddle Strategies in Option Trading

The straddle strategy is an option strategy that's based on buying both a call and put of a stock. Note that there are various forms of straddles, but we will only be covering the basic straddle strategy. To initiate a Straddle, we would buy a Call and Put of a stock with the same expiration date and strike price. For example, we would initiate a Straddle for company ABC by buying a June $20 Call as well as a June $20 Put.

Now why would we want to buy both a Call and a Put? Calls are for when you expect the stock to go up, and Puts are for when you expect the stock to go down, right?

In an ideal world, we would like to be able to clearly predict the direction of a stock. However, in the real world, it's quite difficult. On the other hand, it's relatively easier to predict whether a stock is going to move (without knowing whether the move is up or down). One method of predicting volatility is by using the Technical Indicator called Bollinger Bands.

For example, you know that ABC's annual report is coming out this week, but do not know whether they will exceed expectations or not. You could assume that the stock price will be quite volatile, but since you don't know the news in the annual report, you wouldn't have a clue which direction the stock will move. In cases like this, a Straddle strategy would be good to adopt.

If the price of the stock shoots up, your Call will be way In-The-Money, and your Put will be worthless. If the price plummets, your Put will be way In-The-Money, and your Call will be worthless. This is safer than buying either just a Call or just a Put. If you just bought a one-sided option, and the price goes the wrong way, you're looking at possibly losing your entire premium investment. In the case of Straddles, you will be safe either way, though you are spending more initially since you have to pay the premiums of both the Call and the Put.

Let's look at a numerical example:

For stock XYZ, let's imagine the share price is now sitting at $63. There is news that a legal suit against XYZ will conclude tomorrow. No matter the result of the suit, you know that there will be volatility. If they win, the price will jump. If they lose, the price will plummet.

So we decide to initiate a Straddle strategy on the XYZ stock. We decide to buy a $65 Call and a $65 Put on XYZ, $65 being the closest strike price to the current stock price of $63. The premium for the Call (which is $2 Out-Of-The-Money) is $0.75, and the premium for the Put (which is $2 In-The-Money) is $3.00. So our total initial investment is the sum of both premiums, which is $3.75.

Fast forward 2 days. XYZ won the legal battle! Investors are more confident of the stock and the price jumps to $72. The $65 Call is now $7 In-The-Money and its premium is now $8.00. The $65 Put is now Way-Out-Of-The-Money and its premium is now $0.25. If we close out both positions and sell both options, we would cash in $8.00 + $0.25 = $8.25. That's a profit of $4.50 on our initial $3.75 investment!

Of course, we could have just bought a basic Call option and earned a greater profit. But we didn't know which direction the stock price would go. If XYZ lost the legal battle, the price could have dropped $10, making our Call worthless and causing us to lose our entire investment. A Straddle strategy is more conservative and will profit whether the stock goes up or down.

If Straddles are so good, why doesn't everybody use them for every investment?

It fails when the stock price doesn't move. If the price of the stock hovers around the initial price, both the Call and the Put will not be that much In-The-Money. Furthermore, the closer it is to the expiration date, the cheaper premiums are. Option premiums have a Time Value associated with them. So an option expiring this month will have a cheaper premium than an option with the same strike price expiring next year.

So in the case where the stock price doesn't move, the premiums of both the Call and Put will slowly decay, and we could end up losing a large percentage of our investment. The bottom line is: for a Straddle strategy to be profitable, there has to be volatility, and a marked movement in the stock price.

A more advanced investor can tweak Straddles to create many variations. They can buy different amounts of Calls and Puts with different Strike Prices or Expiration Dates, modifying the Straddles to suit their individual strategies and risk tolerance.

Steven is the webmaster of http://www.option-trading-guide.com If you would like to learn more about Option Trading or Technical Analysis, do visit for various strategies and resources to help your stock market investments.

---

Stocks: Reduce Risk Yet Maximize Profits

It is important to note that every smart investor wants... Read More

Shop More, Save More for College Gimmick or Reality?

The man sat in a chair beside a dressing room... Read More

Investing In Sons Business Could Cause A Real Family Feud

Q: My youngest son wants to borrow $5,000 to start... Read More

Investing & Online Stock & Share Trading- The Stock & Share Markets are Booming But Be Warned

I had the pleasure of being invited on a friend's... Read More

How to Analyze the Veracity of Investment Newsletters

When trying to analyze whether a promotional ad for an... Read More

Discipline in Trading and Investing

The one thing I can think of that most affects... Read More

Asset Location ? Increase Investing Returns & Reduce Your Taxes

Location ? Once the holy grail only for real estate... Read More

The Perfect Economy?

The U.S. economic data reported this week showed strong output... Read More

College Savings Plans ? Are They The Best Choice For My Child?

College Savings Plans ? are they the best choice for... Read More

Why You Need To Buy and Sell Gold Coins (Part 2)

How to Collect Rare Coins For Fun and ProfitTime has... Read More

The Key Ingredient To Increase Preconstruction Profits By Over $20,000

One of the greatest preconstruction investing issues that I hear... Read More

Property Investment Just Got Exciting

There is an area in Brazil that has lower crime... Read More

5 Ways To Protect Your Bond Portfolio From Rising Interest Rates

The Federal Reserve recently raised its target federal funds rate... Read More

Franchise Opportunity Sellers Beware; franchise buyers lie on forms?

It seems completely absurd that franchise buyers lie about their... Read More

Value Investing

By definition, value investing is the process of selecting stocks... Read More

Trading Commodity Futures Using Support and Resistance - Paper Trading

Setting Up a Paper Trading AccountQuestion: I cannot trade with... Read More

Useful Tips on Investing

Here are some useful tips on investing. When you make... Read More

How to Use Annual Report

There are many steps in calculating the fair value of... Read More

Well Managed Investing Risks Bring Rewards!

"Risk comes from not knowing what you're doing!" Warren Buffett... Read More

Everybody Wants to Know How to Invest

Those unfamiliar with the process of making and managing investments... Read More

Landlording 101, Tricks of The Trade

Looking Inside Your Tenant's Mind Basic Mind-Reading Report 101 for... Read More

Investor Guide to Financial Health

Step 1: Spend less than you earnPerhaps the simplest financial... Read More

Investing: The Art Of Making Your Money Work For You

There is a lot to know about investing. It all... Read More

Investing and the Fear of Regret and Greed

People tend to feel sorrow and grief after having made... Read More

Investing: Do You Want To Make Money, Or Would You Rather Fool Around?

It always amazes me how much stock market investors resemble... Read More

When It Comes To Investing, Asking The Right Questions Can Help You Make The Right Decisions

Are you ready to open your pathway to financial independence?Well... Read More

Finding the Perfect Company

The perfect company - it's the holy grail of the... Read More

Moving Average Convergence Divergence ( MACD ) Charts

The Moving Average Convergence Divergence charts, or MACD charts for... Read More

Investment Rowing

You have rowed a boat at some time haven't you?... Read More

Wit and Wisdom on Money, Wall Street and Success - Part #2

Here are ten more WISDOM packed GEMS that ooffer very... Read More

Justify Social Security ... Dont Save for Retirement

It is a common question when investors review their retirement... Read More

Rules for Simplified Employee Pension Plans better known as a SEP Plans

A SEP is a special type of IRA. Under a... Read More

Retirement ? Its Sooner Than You Think!! (Honestly)

Many people hear "retirement" and think- what? 401K? Roth vs.... Read More