Understanding How Straddle Strategy Works

Trading involves plenty of sophisticated strategies meant to help traders in succeeding in their efforts regardless of the market’s movement. A straddle is an option strategy that requires the sale or purchase of a call and put to become activated.

Kinds of Straddles

A straddle can be accomplished by holding an equal number of calls and puts with the same expiration dates and strike price. This strategy can be.

  •  Long straddle- This is designed around buying a call and a put at the precise expiration date and strike price. It is meant to assist traders in catching profits whether the market goes up, down or sideways. If the market moves sideways, it is not easy to know whether it will break to the downside or upside. By buying a call and a put, traders can catch the move of the market regardless of its direction. The call is there when the market moves up and the when it moves down, the put is there.  In terms of buying options, at-the-money and in-the-money options are pricier than out-of-the-money options. Every at-the-money option can be worth a few thousand dollars.
  • Short Straddle-Rather than buying a call and a put, a call and a put is sold to generate income from the premium. The money that buyers of calls and puts spend will fill your account. For any trader, this can be a good boon. But the downside is if you sell an option, you are exposed to a lot of risks.
  • The short straddle option is good as long as the market doesn’t move up or down in price. The most profitable scenario includes the erosion of the intrinsic value and time value of the call and put options. In case the market picks a direction, the trader should pay for any accrued losses and gives his collected premium back. A short trader’s only recourse is buying back the options he sold if the value justifies doing so. Such can take place at any time during a trade’s life cycle.

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When to Expect Straddles to Work Best

The option straddle tends to work if it meets at least one of the criteria below.

  • There is pending earning, announcement or news.
  • The market moves sideways.
  • Analysts have extensive forecasts on a certain announcement.

Analysts can tremendously affect the react of the market before an announcement is made. Before government announcements or earnings decisions, analysts will do their best in order to predict the announcement’s precise value. It is likely that analysts make estimates many weeks in advance of the day the announcement will be made that forces the market to move down or up.

After the release of the actual number, the market will show sign of fatigue or proceed in the direction of what analysts forecast. A straddle that is properly created can successfully benefit from this kind of market scenario. The challenge arises in determining when to use a long or short straddle. Such can be determined if the market moves counter to the news and if the news adds to the momentum of the direction of the market.

Author Bio – Kim Klaiman has written hundreds of articles about options trading. He likes trading non-directional options strategies.