Previously, I have tackled directional options trading with Credit Spreads. Directional Trading means trading the markets or a specific stock with a specific view of it going up or down (bullish or bearish). This week, I'd like to focus on a different options trading strategy called Straddles.
A Straddle is a neutral or non-directional options trading strategy. In essence, neutral or non-directional options trading strategies are opted by options traders when he has no idea as to whether a particular stock would rise or fall. In such options trading strategy, the profit potential is assessed on the basis of speculative volatility of a particular stock price. There are 2 types of straddles: a Long Straddle and a Short Straddle. This post will cover the Long Straddle as an options trading strategy.
Long Straddle
A Long straddle is basically comprised of a Buy Call and Buy Put Options. The idea is you are buying a call and a put on same strike price. With this options trading strategy, if the market goes in one direction, one of the options will increase in value significantly, and the other will become worthless. For a long straddle to be effective, the price of a stock should either take a huge jump or go for a steep decline. This is very handy for times when the market is very volatile, and the volatility can enable you to earn unlimited amounts based on how much the stock price has risen or fallen.
Profits are calculated based on where the stock price is. If the stock price is above the strike price of the option, then the profit will be as follows:
Price of the stock - Strike Price of the Call option - Net Premium Paid
If the stock price is below the strike price of the option, then the profit will be as follows:
Strike Price of the Put Option -Price of the stock -Net Premium Paid
For example:
Company XYZ is trading at $40. You do a straddle by buying 10 call and 10 put options of $40. You paid $400 in premium.
If at expiry date the stock price is now at $50, then your profit is as follows:
($50 x 10 contracts) - ($40 x 10 contracts) - $400
If at expiry date the stock price is now at $30, then your profit will be:
($40 x 10 contracts) - ($30 x 10 contracts) - $400
If the stock price did not move at all by expiry date, you lose the premium you would have paid, and both options have now expired worthless.
If you would like to learn more about Straddles and options trading in general, I found that Planet Wealth provides very comprehensive information on stock and options trading, and the various strategies that you can use depending on the market situation.
On my next post, I will be covering short straddles. I hope you've enjoyed this post and learned something from it.
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