Long Straddle Options: Working and Strategy | Espresso

All About Long Straddle Options Strategy

With Options trading in the stock market, you can make large profits by making relatively smaller investments. It allows you to buy or sell a certain quantity of stocks of a certain company at a specific price and within a specific date.

Published on 07 April 2022

This type of trading provides you with the flexibility to either buy the stocks at a specific price within a specific date or let go of the premium you’ve paid for them.

Although options trading allows you to gain larger profits with little investments, you need to remember that they are heavily risky. If you’re a seasoned options trader, you must have experienced a situation wherein you take a call or a put option, and right after your trade, the market starts to move in the opposite direction.

In such situations, the value of your options contract dies down quickly, and you may lose all your money. To avoid such situations, professional options traders adopt certain trading strategies. They go beyond unidirectional trades and use these strategies to shield themselves against unpredictable market movements.

One such strategy is the long straddle options strategy. In this article, we’ll discuss the long straddle strategy and how it can help you make money through options trading. Let’s get started.

What is a Long Straddle Options Strategy?

A long straddle strategy is perhaps the simplest options trading strategy that can help you neutrally approach the market. Once you implement this strategy, the direction of the market movement does not matter to you. As a result, you can make money irrespective of whether the market shows a bearish move or a bullish move.

The long straddle options strategy is a strategy where a trader buys both a long call and a long put options contract of a particular stock with the same expiry date and strike price.

Putting it in simpler words, to implement a long straddle options strategy, you need to do the following:

  • Buy a Call Option of a particular stock or index
  • Buy a Put Option of the same stock or index
  • Make sure that both call and put options belong to the same expiry date and same strike price
  • Both the options should be purchased at the same time with an almost similar spot price

Let’s consider a long straddle example to understand this strategy better. Suppose the Nifty index is currently trading at 17500. So, you can simultaneously purchase a call and a put option at a strike price of 18000 by paying the premiums for both.

How Long Straddle Options Strategy Work?

When you implement the long straddle strategy, you need to take both the call and put options at the same strike price. Now, if the market shows bullish movement, the premium of your call option would start rising, and you will make good gains in it. This would overcome the losses you incur in your put option.

Similarly, if the market shows bearish movement, the premium of your put option would start rising, and you will make substantial gains, overcoming the losses you may incur in your call option. Hence, irrespective of the direction in which the market moves, you are bound to make profits by implementing the long straddle options strategy.

However, the market must show enough volatility in one direction so that the profits generated by you in that direction overrules the losses incurred in the other direction.

In the long straddle example mentioned above, if the Nifty moves towards 18000, then the value of your 18000 CE Option will start rising, and you will make significant gains. On the contrary, if the market shows a bearish trend and the Nifty moves towards the 17000 mark, then the value of your 18000 PE Option will start rising, resulting in substantial profits.

Risks Involved in This Strategy

Although the long straddle options strategy has the potential of providing unlimited gains, it’s a bit risky as well. After all, there is no options trading strategy with zero risks. The maximum loss you can incur in this strategy is the sum of the premiums you paid for both the call and put options, along with the commissions you need to pay to your stockbroker.

This happens when both the options are held till their expiry, but they do not witness fluctuations in their premiums. Both options expire worthless when the price of the underlying asset stays within the spot price and the strike price at expiration.

Hence, market volatility matters quite a lot when you take positions using the long straddle strategy. Although the direction of the market movement doesn’t matter in this strategy, it has to move rapidly in one of the two directions.

To mitigate the risks associated with the long straddle options strategy, you can adopt the short straddle strategy. This strategy is exactly the opposite of the long straddle strategy. Here, you need to buy a short call and a short put of the same stock and same expiry date and strike price. This strategy works well even when the markets are less volatile.

Conclusion

The long and short straddle is one of the best strategies to make gains through options trading. However, you must be aware of the risks associated with this strategy and the options trading before you invest your hard-earned money.

 

Chandresh Khona
Team Espresso

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