How Does the Straddle Options Strategy Work?

What is a Straddle?

Investors and traders use different strategies to hedge risk when trading. A straddle is one of those strategies. Straddle refers to spread across or cover. In this trading approach, a trader purchases a call and a put option with the same strike price and expiration date at the same time.

It is employed when a trader anticipates a sizable change in the underlying asset's price but is unsure of its direction. With a straddle, the trader might benefit from a rise in price. A straddle also limits possible losses while enabling the trader to profit from a price gain or decline, independent of the direction.

 

Types of Straddle Options Strategies

There are two different types of straddles you must know to create a strong option strategy:

• Long straddle strategy: It involves buying both a call and a put option with the same strike price and expiration date. It is employed when a trader thinks that the price of the underlying asset will fluctuate significantly but is unsure of the movement's direction.
• Short straddle: It involves selling both a call and a put option with the same strike price and expiration date. When a trader anticipates that the price of the underlying asset will stay mostly constant or fall within a particular range, they use this technique.

 

How Does a Straddle Option Strategy Work?

When a trader initiates a long straddle position, they are essentially combining two separate options positions. One part profits from an increase in the price for the underlying (~call option~). The second, on the other hand, is profiting from a decrease in this price (~put option~). 

This way, the trader is actually ‘covered’ because the position gains if the underlying asset moves by more than the points marked on the graph as breakeven. Nevertheless, if the price movement in the underlined is not high and does not go beyond the breakeven points, the trader is likely to lose money.

The short straddle is the complete opposite of the long straddle strategy. It allows traders to approach low market volatility or sideways movement in the underlying in a much different way. In the short straddle strategy, the trader sells both a call option and a put option with the same exercise price and expiration period.

This strategy is used when the trader assumes that the underlying asset price will not change much or may fluctuate only a narrow range before the expiration. Again, the long straddle used by the trader makes a profit in large price swings, while the short straddle is used when prices move less.

 

Conclusion

Long and short trades are special due to the fact they grant very different risk characteristics in comparison to a long or short position in a stock. This is why the options strategy involves making both a call and a put with a similar exercise price and expiration of the option. The long straddle is appropriate for a situation where higher fluctuation is expected, but its direction is unpredictable, while the short straddle is used frequently in a stable or range-bound market.