Long Straddle: How Your P/L Behaves

How to create a long straddle

A straddle is the simplest non-directional trade you can make with options. A straddle is a combination of a call and a put option with the same underlying asset, same expiration date, and most importantly, same strike price. In short, all the basic characteristics of both options you buy are the same except for one option being a call and the other being a put.

When you buy both options simultaneously, you have a long straddle. When you sell both, you have a short straddle position.

Long straddle example

For example you can create a long straddle position by buying a call option on Microsoft stock with strike price of 20 and at the same time buying a put option on Microsoft with strike price of 20. Same underlying, same expiration date, same strike, only one is call and the other is put.

Let’s say Microsoft stock (the underlying) is trading at 20 at the moment and you buy the call for 1.80 and the put for 2.20. The total price you pay for this straddle (initial cost) is the sum, which is 4 dollars.

Intrinsic and time value of a straddle

When Microsoft is trading at 20 (which is exactly the strike price of both options), both options are at the money. Options which are exactly at the money have zero intrinsic value and their entire market price is made up by time value.

Profit and loss scenarios of a long straddle

If you plan to hold the straddle till expiration, how far does the stock need to go for you to make a profit? Let’s think about a few scenarios:

Long straddle profit and loss summary

From the scenarios above you can see that the further the stock price goes from the strike price (which is same for both options), the more money you make. But before you start making a profit, you must pay for the initial cost of the straddle. The breakeven points are:

The most you can lose is your initial investment (4 dollars in our example), if the stock stays exactly at the strike price. The most you can make is theoretically infinite (if Microsoft stock price goes to 1,000 in our example, you make 976 dollars).

Non-directional and long volatility trade

Long straddle is a non-directional trade, as you don’t really care if you make money due to the stock going up or down. Long straddle is also a long volatility trade – the more the stock moves, the greater your chance for a profit.