Long straddle is a non-directional long volatility strategy. This page explains its payoff, maximum profit and loss and break-even points. It also provides recommendations and tips for trading long straddles.
Long Straddle Options
A long straddle position consists of two options:
- Long call
- Long put
Both options have the same strike price (this is how long straddle differs from long strangle) and the same expiration date.
Long Straddle Payoff Diagram
Long straddle strategy makes a profit when underlying price gets away from the options’ strike price to either side. The further it gets, the higher the profit. Potential profit is theoretically infinite. Conversely, the trade is a loss if underlying price stays close to the strike.
Here you can find detailed explanation of long straddle payoff and the sources of its risk and profit exposures.
Long Straddle Break-Even Points
Long straddle payoff has two break-even points, both at the same distance from the options’ strike to each side. The distance is equal to the initial price of both options. In other words, for a long straddle position to become profitable, the underlying price must get at least as far away from the strike (to either side) to offset the initial cost of the entire position.
Long straddle B/E #1 = strike price – initial cost per share
Long straddle B/E #2 = strike price + initial cost per share
Long Straddle Maximum Profit and Loss
Long straddle strategy has limited risk. Maximum possible loss is equal to the initial price you pay for both options. It applies only when the underlying price is exactly equal to the options’ strike price at expiration.
Profit potential is unlimited. The profit is the higher the further away from the strike the underlying price gets to either side.
Long Straddle Risk/Reward Ratio
With limited risk and unlimited potential gain, a long straddle position has infinitely high reward/risk ratio.
Trading Long Straddle Strategy
Long straddle is a long volatility strategy and may be suitable when you expect the underlying price to move a lot – generally you expect the actual realized volatility to be higher than implied volatility of the options you buy. With a long straddle position you expect the underlying price to get far away from the strike, but you are not sure about the direction.
When deciding about the strike, it is most common to use the one closest to the current underlying price at the time of opening a long straddle position. However, in some cases when you have a directional bias (consider a move in one direction more likely than the other), you may choose options one or more strikes up or down from the current underlying price. In any case, the strike must always be the same for the call and the put.
Option Strategies Similar to Long Straddle
The strategy closest to long straddle, in name, payoff profile and use, is long strangle. The only difference is that with a strangle the strikes of the two options are different – the call strike higher than the put strike. As a result, the cost (and therefore maximum possible loss) of a long strangle is lower than the cost and risk of long straddle, but the maximum loss applies on a wider range of prices and the two break-even points are further apart. In other words, a long strangle position is cheaper to set up, but you generally need the underlying to move further to make a profit.