Long Straddle Payoff Explained
The page provides detailed explanation of long straddle payoff and the sources of its risk and profit exposures.
Long Straddle Payoff
Long straddle is a non-directional long volatility strategy. It is generally suitable when you expect the underlying security to be very volatile and move a lot, but you are not sure whether the price move will be up or down. The position makes a profit when your expectation is correct and the underlying does make a big move to one or the other side. If you are wrong and the underlying price stays more or less the same, the trade makes a loss.
Long Straddle Options
A long straddle position consists of two legs: a long call and long put, both with the same strike and the same expiration.
The call option provides profit exposure to the bullish side. The profit rises in proportion with underlying price.
The put option provides profit exposure to the bearish side. The profit rises as the underlying price declines.
Long Straddle Payoff Diagram with Legs
Both the call and the put of course come at a cost. The initial cost of the two options combined is the maximum possible loss of a long straddle trade, which applies only when underlying price is exactly equal to the options’ strike price.
As the underlying price rises above the strike, the call option gets in the money, while the put option is out of the money. If the price gets high enough, the call option’s value is high enough to offset the initial cost of both options and the trade becomes profitable. Conversely, as the underlying price falls below the strike, the put option is in the money and the call is out of the money. With a long straddle trade, you can always profit only on one of the options, so the underlying price must get far enough from the strike for the option’s value to offest the cost of both options and for the trade to make a profit.