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Long Straddle
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| Risk: |
Limited, but this is not a low-risk strategy because a Straddle is normally expensive to buy and both options are wasting assets. |
| Reward: |
Unlimited |
| The Trade: |
an at the money or near money call and put option are bought with the same strike price. |
ABC Stock trading at £5.00
Buy 1 Sep £5.00 call and buy 1 Sep £5.00 put (see pay-off diagram below)
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| When to use: |
You believe that a stock is about to make a large move in either direction. A good time to utilise straddles is where there has been a prolonged period of extreme quietness (in prices) and implied volatility is around multiyear lows.
If this is the case look to do longer dated months rather than the shorter ones.
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| Volatility expectation: |
Very bullish. Volatility increases improve the position substantially. However if a straddle is bought when volatilty is high it's tough to make a profit. |
| Profit: |
Unlimited if stock prices rise but semi-unlimited if stock prices decline as a stock cannot trade less than zero. |
| Loss: |
Limited to the premium paid in establishing the position. Loss will be greatest if the underlying is at the initiated strike at expiry. |
| Breakeven: |
Reached if the underlying rises or falls from option strikes by the same amount as the premium cost of establishing the position. |
| Time decay: |
Hurts a lot, remember you have double time erosion because of the two options bought. Decay depends a lot on volatility if volatility increases time decay will decrease. |
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Trading ideas and tactics:
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- Work best on stocks/markets that are likely to experience explosive moves
- Consider 'legging' into them - buying the calls today and buying the puts on a rally or vice-versa
- Always best to use some sort of time stop because of the time decay, ie if the stock hasn't moved significantly within 2 weeks consider getting out
- If you're expecting a very large breakout then better to trade strangles
- Very hard trade to make money on if you buy the options when volatility is high
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