When this happens, volatility tends to expand, and the straddle benefits. The maximum profit for long straddle is theoretically unlimited for the upside, and capped at the underlying asset going to zero on the downside.
The maximum loss is always the total sum of the premium spent for buying the long call and put options. The long straddle option strategy a unique way to create a situation with unlimited profit either up or down that has a very conservative and limited loss.
Traders commonly place long straddles ahead of earnings reports, FDA announcements, and other anticipated binary events. Because the long straddle option strategy is entirely risk-defined, margin requirements are simple.
The buying power requirement for all long options positions is equal to the sum of the option premium. In the case of the long straddle, the total premium spent is the margin requirement, and always will be for the entire duration of the trade.
If the underlying asset like a stock, futures contract, index, etc. This means timing is very important. Because there is an unlimited profit potential on the upside and a very large profit potential on the downside, it is difficult to know precisely when to close out a profitable long straddle.
Basically, a long straddle is tantamount to being simultaneously long and short the same asset. Therefore, you should close out a long straddle whenever you would normally close out a long or short position. If a long stock position is not wanted, the call must be sold prior to expiration.
If the stock price is below the strike price at expiration, the call expires worthless, the long put is exercised, stock is sold at the strike price and a short stock position is created. If a short stock position is not wanted, the put must be sold prior to expiration. Long straddles involve buying a call and put with the same strike price. For example, buy a Call and buy a Put. Long strangles, however, involve buying a call with a higher strike price and buying a put with a lower strike price.
For example, buy a Call and buy a 95 Put. There are three advantages and two disadvantages of a long straddle. The first advantage is that the breakeven points are closer together for a straddle than for a comparable strangle. Third, long straddles are less sensitive to time decay than long strangles. Thus, when there is little or no stock price movement, a long straddle will experience a lower percentage loss over a given time period than a comparable strangle.
The first disadvantage of a long straddle is that the cost and maximum risk of one straddle one call and one put are greater than for one strangle. Second, for a given amount of capital, fewer straddles can be purchased. The long strangle two advantages and three disadvantages. The first advantage is that the cost and maximum risk of one strangle are lower than for one straddle. Second, for a given amount of capital, more strangles can be purchased. The first disadvantage is that the breakeven points for a strangle are further apart than for a comparable straddle.
Third, long strangles are more sensitive to time decay than long straddles. Thus, when there is little or no stock price movement, a long strangle will experience a greater percentage loss over a given time period than a comparable straddle. A long strangle consists of one long call with a higher strike price and one long put with a lower strike.
Reprinted with permission from CBOE. The statements and opinions expressed in this article are those of the author. Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data.
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The Strategy A long straddle is the best of both worlds, since the call gives you the right to buy the stock at strike price A and the put gives you the right to sell the stock at strike price A. Options Guy's Tips Many investors who use the long straddle will look for major news events that may cause the stock to make an abnormally large move. Both options have the same expiration month.