A straddle options strategy is a neutral options strategy that involves simultaneously buying both a put option and a call option for the underlying security with the same strike price and the same expiration date.
Successful options traders have learned the value of trading options straddles.
David Jaffee of BestStockStrategy.com teaches his students how to sell option premium for a profit.
However, David Jaffee also acknowledges that some options trading strategies work best in certain situations.
A straddle is best SOLD when a trader expects that the underlying stock will not move much (and that the actual volatility will be less than the expected volatility).
Keep reading to learn more about this options trading strategy, including why and when investors use an options straddle.
What is a straddle option?
A straddle is a type of options trading strategy that involves both a call option and put option.
Call and put options are typically at opposite ends of the trading spectrum, but there are instances when utilizing both option types can be profitable.
If a trader anticipates that the price of a stock will move significantly but is unsure of the direction, a LONG straddle (buying a call and put options) can lead to profits.
A straddle option, also known as a neutral trade combination, involves two separate legs. The trader can either buy or sell both a call and put option at the same time.
The call and put option are set at the same strike price and the same expiration date.
Ideally, the call and put options will offset any losses in the event that one of the options fail.
For option BUYERS, a straddle option can be profitable if the price of the stock rises above the strike price or falls below the strike price by an amount more than the total premium paid to enter the trade.
To execute a long straddle options trade, you will pay a premium for both the call and put options.
For option buyers, the maximum potential for loss with a straddle option is the total amount of premiums paid.
If the price of the underlying asset changes dramatically, only one of your options contracts will have intrinsic value.
The value of your profitable contract will hopefully be enough to earn a profit on your overall position.
If it all sounds confusing, you can rely on the best options trading coach to guide you.
Straddle Option Example
Consider a stock currently trading at $60.
You expect that the price of the stock will rise or fall significantly before June 1.
You can create a straddle by purchasing a put at a strike price of $60 and a call at the same strike price.
The total cost of your straddle is the price of both option premiums. If both premiums cost $3.00, the total premium price for both contracts would be $6.00 (remember that 1 contract is 100 shares, so each premium will be $300 each, or $600 in total).
Your profit depends on how much the stock rises or falls, or the magnitude of the move.
You can divide your total premium paid by the strike price for your options. That number equals the percentage that the stock needs to rise or fall in order for you to earn a profit.
When should you use a straddle strategy?
A straddle option seems complicated, and call and put options are already tricky enough.
So, when should you use an options straddle?
Volatile markets are the best times to BUY straddle options.
The more the price of the underlying stock moves in either direction, the more valuable your puts and call options become.
However, options prices will already be very high during periods of high volatility, with elevated VIX. As a result, it may be best to buy an options straddle during periods when VIX is trading around 15.
If many investors buy options on an individual stock, then the price of those straddles, and the individual puts and calls, will increase.
If volatility is not widely expected (and the VIX is relatively low), you can open a straddle position for less upfront cost.
During a quiet market, you may have a better chance of earning a profit on your straddle position.
It is important to remember that straddles are not among the best options trading strategies due to their high risk.
What is a long straddle?
A long straddle involves buying a call and put option at the same strike price and expiry date.
Long straddles have low risk (but also low probability of profit), and the maximum loss is the total premium paid.
Low implied volatility is typically an entry signal for long straddles.
What is a short straddle option?
A short straddle involves selling a call and put option at the same strike price and expiry date.
The risk for short straddles is unlimited because it is possible to lose the entire value of the security if both options are sold (you also have unlimited risk on the short call side, and your maximum loss on the short put side would be if the stock were to fall to $0).
The maximum profit for a short straddle is the premium received for both options.
David Jaffee Reviews Straddles – What does David Jaffee think about Straddles?
Let me make this very easy for you.
I DO NOT TRADE STRADDLES. I believe that they are very risky.
At BestStockStrategy.com, we sell option premium, however we also believe that it's worthwhile to have a safety net in place for every position that we sell.
When selling a straddle, oftentimes traders sell them at-the-money (“ATM”).
By selling an ATM straddle, you will have a greater than 50% chance of profit due to collecting premium and theta decay, and I also know that there are studies that shows decent profits from selling ATM straddles when closing out the position early (at 25% or 30% profit).
However, for me, I don't think it's worth the stress or the risk.
When selling ATM options, you will have to constantly monitor your positions to ensure that they don't get too far ITM.
While the probability of profit of selling an ATM straddle may be higher than 50%, the expected probability may be negative due to the fact that you'll lose dollar-for-dollar on the short options once they become in the money, while your maximum profit will be the amount of premium collected.
In addition to the stress of having ITM positions, the call side of straddles tend to get tested very frequently.
So yes, I understand that selling ATM straddles have a high probability of success, but, for me….it's not a trade that I would make.
I prefer to sell OTM options (mostly put options).
In terms of buying ATM straddles, I wouldn't recommend that either because I feel that buying options is similar to gambling.
What is the best straddle option strategy?
If straddle options have your head spinning, don’t worry.
David Jaffee can help you understand the ins and outs of straddle options, including the best time to implement a straddle strategy.
Enroll in real-time trade alerts from David Jaffee to follow his actual trades and discover the potential of options straddles.
Frequently Asked Questions (FAQS)
Is there a long straddle options strategy?
Yes, you can buy options on stocks that you feel will move significantly in the near future. The probability of profit on this trade is less than 50%, but the expected profit on this trade may be positive depending on whether actual volatility exceeds expected volatility.
A straddle options strategy involves buying (or selling) a call and a put of the same strike and same expiration date, whereas a strangle involves buying (or selling) an out-of-the-money (OTM) call and put of the same expiration date but different strikes.
Should I use a spread when trading straddles?
Personally, I would use spreads when trading straddles to reduce your risk. I would also close out any straddles early after they've achieved a ~25% or 35% gain.