Stock options trading straddle strategies
Many investors who use the long straddle will look for major news events that may cause the stock to make an abnormally large move. Look for instances where the stock moved at least 1. Lie down until the urge goes away. At first glance, this seems like a fairly simple strategy. However, it is not suited for all investors. If the stock goes down, potential profit may be substantial but limited to the strike price minus the net debit paid.
For this strategy, time decay is your mortal enemy. After the strategy is established, you really want implied volatility to increase. It will increase the value of both options, and it also suggests an increased possibility of a price swing.
Conversely, a decrease in implied volatility will be doubly painful because it will work against both options you bought. If you run this strategy, you can really get hurt by a volatility crunch. Options involve risk and are not suitable for all investors.
For more information, please review the Characteristics and Risks of Standardized Options brochure before you begin trading options. Options investors may lose the entire amount of their investment in a relatively short period of time.
Multiple leg options strategies involve additional risks , and may result in complex tax treatments. Please consult a tax professional prior to implementing these strategies. Implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or the probability of reaching a specific price point.
The Greeks represent the consensus of the marketplace as to how the option will react to changes in certain variables associated with the pricing of an option contract. There is no guarantee that the forecasts of implied volatility or the Greeks will be correct. Ally Invest provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice. System response and access times may vary due to market conditions, system performance, and other factors.
To apply it you must purchase at the money calls and also the same amount of at the money puts. These transactions would typically be made simultaneously, and you should use the same expiration date for both sets of contracts. A long term expiration date will allow plenty of time for the price of the security to move, and give you a greater chance of making big profits. A short term expiration date won't allow so much time for the price movement, but the contracts will be cheaper so you can potentially profit from a smaller movement.
There's an upfront cost involved, making this a debit spread. You may not be able to purchase options that are exactly at the money, in which case you should buy the options that have the closest strike to the current trading price of the security. We have provided an example below of how you can apply a long straddle.
Please note that we have used hypothetical prices rather than real market data to keep this example as simple as possible. We have ignored commission costs for the same purpose. Each leg of the long straddle can make potentially unlimited profits if the price of the underlying security Company X stock in this case makes a big move in the right direction, and you can only lose the amount spent on establishing the leg.
Therefore the spread will return an overall profit providing that one leg makes a large enough return to cover the cost of the other leg. This means that a stagnant price, or very little movement, will result in an overall loss.
The loss is limited though, while the potential profits are unlimited. Below we have highlighted what the results would be of our example in some different scenarios. We have also provided some formulas for calculating the potential profits, losses, and break-even points. You don't necessarily have to wait until expiration with the long straddle, and you can close the position early at any time by selling the options. If it looks like the price of the security is not going to move sufficiently in either direction, you can close the position early to cut your losses and recover the remaining extrinsic value in the options along with any intrinsic value.
If the position is in profit, you can close the position early to realize any profits made. The long straddle is a great strategy to use when you are confident that a security will move significantly in price, but are unable to predict in which direction.