The straddle option allows the investor to profit from the option if the underlying security makes a significant move in either direction. The straddle option is actually a combination of a call option and a put option with the same underlying security.
A long straddle is an options strategy that involves buying a call option and a put option on the same underlying with the same strike price and expiration. The investor using a straddle trade will make money if the underlying either moves up or down in value.
The investor exercises the call option if the value of the underlying rises above the strike price. When the underlying security rises in value above the strike price, the investor allows the put to expire out-of-the-money.
The put option of the straddle is exercised if the underlying falls below the strike price. The call option expires out-of-the-money when the underlying value decreases.
The risk of buying a straddle is if the underlying security does not move in value as expected but rather stays stable or moves very little. With little or no movement, the put and call options would expire out-of-the-money and the investor would lose the option premiums paid for the options.
A strangle is similar to a straddle investment strategy. Instead of the call option and put option having the same strike price, a strangle is a call option at a higher strike price and a put at a lower strike price.
A short straddle is selling a call option and a put option on the same underlying security with the same expiration and strike price. The risk of a short straddle is if the stock moves significantly higher or lower and the buyer exercises the options.
The short straddle is also called selling straddles. The potential profit of the short straddle is limited to the premiums collected for selling the call option and put option. The seller of the call and put options keep the premiums as profit if the stock or other underlying security fails to reach the strike price for either option.
Unlike the long straddle, the potential risk of loss for a short straddle is practically unlimited. Therefore, selling straddles is considered a very risky trading strategy.
The option greeks for straddles are not difficult to understand. The delta of straddles varies depending on the stock price compared to the strike price.
The gamma of a long straddle is always positive. The gamma of the short straddle is always negative. Long straddles have positive vega. Short straddles have negative vega.
The expected profit of straddle options may be less than what an investor first expects when looking for a long straddle. If the market expects a stock to make a big move, the stock option premiums may also rise which makes the investment more expensive.
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