BAJAJ BROKING
February 12, 2025
7 mins read
Options trading can be extremely volatile and market predictions decide the overall profit or loss for a trader. At times, traders are ready to buy a long trade but unsure of the direction of movement. This is when a long straddle technique comes into use. A long straddle is one of the popular strategies that help beat the uncertainties of the market movement to some extent. The idea is to benefit from a strong movement in either direction by purchasing both call and put options for the same asset. So, irrespective of the price movement, the trader is likely to benefit.
A long straddle is usually an options trading strategy. In this strategy, the traders purchase both call and put options of the same asset. Both the trades have the same expiry date and the same strike price as well. This strategy is usually implemented by a trader when they are not very sure of the price movement of an asset. So, to maximise their profit probability, a long straddle strategy is practiced.
A significant price movement in either direction can benefit the trader with remarkable profit. With long price movements, it is also possible to cover the cost of the premium paid to purchase both trades. However, if the anticipated strike price does not hit, the trader can experience a significant loss of premium for both trades. So, a long straddle is best when a large price movement is expected.
Also, in a long straddle, the price rise is unlimited, stating huge profits for the trader while premiums are limited for both trades. The long straddle strategy is only a smart choice in a highly volatile market. In low volatility, the trade may not touch the strike price and so, the trader may end up losing.
Before implementing a long straddle strategy, you must also be aware of the short straddle. In the latter, you sell call and put options. In a short straddle, the trader benefits from low volatility and short price movements,, unlike a long straddle.
Implementing a long straddle strategy is simple and straightforward. As discussed above, you need to purchase a call and put on a similar trade. Make sure to make an informed decision while choosing between long or short straddles. While long straddles are good in markets that anticipate large price movements and high volatility, the opposite market situation is ideal for short straddles.
You need to take care of the following things when going with a long straddle strategy:
Buy a call and put an option trade
Both trades must belong to a similar trade
The strike price and expiration date also must be the same.
Let's understand the long straddle strategy with the help of an example.
Suppose a trade is running at ₹8500. At this strike price, a trader purchases a call and a put option for ₹340 each. So, the total cost of the premium is ₹680. Now, there are three possibilities for the market:
The price increases
The first condition can be when the price increases. Suppose if the price moves up to ₹10,000, the trader will make a profit of ₹1,500. Since the price movement was upward, the put option will become worthless. So, the net profit will be 1500-680= ₹820.
The price decreases
In another condition, the price movement may go down in a decreasing trend. Suppose the price touches ₹5,000, the trader will make a profit of ₹3,500. Deducing the cost of premium, the net profit will be ₹2,820.
The prime remains stagnant
In the worst-case scenario, if the price does not move at all, it will remain stagnant at the strike price of ₹7500. So, in this case, the trader will experience a net loss of ₹680, the premium cost.
Long straddle is ideal for marker scenarios when the trader is expecting high volatility. However, since the movement is not very clear, going with both call and put is the best-case scenario. The decision must be based on detailed research of the market because a stagnant market can lead to an absolute loss of premium and no profit.
The market price of an asset is affected by multiple factors. When it comes to long straddle strategy, the following conditions can impact the market movement:
Earnings reports
Announcements of the US Federal Reserve
Legislative decisions
Political events both national and international
These are some of the significant events that may affect the decisions of a company and, eventually, the market price of its assets. So, it is essential to have a stronghold of the changing market landscapes to critically predict market movements.
Long straddle helps cover the limited risks while offering the scope of unlimited profits. However, the profit is subject to high market volatility. If the market ends up being stagnant or shows low volatility, it may not even touch the breakeven point, thus, resulting in bleak profit to even loss of premium.
Since a long straddle is implemented when high market price movement is expected, traders can actually make huge profits. When the price increases or decreases by high margins, the trader can easily cover the premium cost and end up making a profit. Irrespective of the direction of the market price movement, the trader will benefit as long as there is high volatility.
Anyone who is unsure of the market price movement but anticipates high volatility can benefit from a long straddle strategy.
One of the highlighting drawbacks of long straddles is when the market does not react according to your predictions. So, what do you lose in this scenario? Well, not just the anticipated profit but also the entire premium paid.
Since market news reaches nooks and corners of the stock market, the traders on the other end also realize the market anticipations. Hence, they tend to increase the call and put prices. So, unlike in a normal market scenario, in a straddle, you may actually end up paying more price for buying a call and put options. Sometimes, the cost may even be more than what you could have paid to buy in one direction.
So, in such a scenario where you have paid higher premiums, if the market fails to move significantly, you end up making huge losses. The newsworthy event can impact a market movement in either direction and if the movement is not large enough to hit the breakeven on either end, the trade becomes worthless.
There is probably no one way of leveraging long straddle strategy. Traders often use it differently than the conventional ways to make huge profits. The other way of using long straddles is actually buying a call and putting options a few weeks before a scheduled newsworthy event.
So, unlike a typical long straddle strategy where a trader buys a call and puts options when the news has been announced, in this alternative, the trader buys a call and puts weeks before the event happens.
Now, to benefit from this alternative strategy, the trader also needs to sell the options a day before the event happens. Here, the trader anticipated news of the price movement after the event to make a profit. Rather, they benefit from the increase in the demand for call and put options that occur due to specific news of an upcoming event.
Anticipated news may lead to an increase in the price of call and put options weeks before the actual event happens. So, here the trader benefits from the rise in the price of call and put and not from the actual price movement of an asset.
However, options have a characteristic of time decay. The value of options decreases due to time decay as they head close to the expiration day. So, it is ideal to choose options that may have the least impact on the time decay.
To maximise profit from long straddle strategy, you need to enter the market at the right time. You must buy the call and put options when the market has just begun to move. In the meantime, the movement may double or triple until the expiration date. That's how you can get the maximum profit.
If you are anticipating a large price movement of premiums, implementing a long straddle can be highly profitable. It lets you leverage the price movement, irrespective of its direction. However, if the market shows low to no volatility, the loss of premium can be significant. So, making an informed decision is the key to avoiding unnecessary losses!
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Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.
This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
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Primarily, a long straddle strategy let's you make profit irrespective of price movement of an asset. Yes, whether the price increases or decreases, a long straddle strategy ends up profiting. However, the market movement must be long enough to cover the cost of premium and result in significant profit.
Long straddles are implemented by traders when they anticipate long price movements. However, they are unsure of the direction in which the price may move; upwards or downwards. So, to ensure profit irrespective of the direction of price movement, the trader uses a long straddle strategy.
Long straddle is a good strategy when the market experiences high volatility in price movement. However, if there is low volatility or no price movement, it may not be the right approach.
Not really. Long straddles leverages on either direction of the price movement. So, it can be both bullish and bearish.
Yes, you may long use long straddle for both stocks and indices as it allows you to purchase both call and put options.
Setting up a long straddle strategy simply requires you to purchase both call and put on a similar underlying asset. The strike price and the expiration date of the asset just also be same.
A long straddle benefits if the price movement is long enough in either direction. If the price moves, the trader makes the net profit in the following way:
Net profit= Total profit - premium paid (both call and put).
So, whether price goes up or down, as long as the movement is long, the trader is expected to profit.
If the price of an asset remains stagnant, the trader will make a net loss of the premium paid for both call and put options. The loss can be significantly large if the premium costs were quite high.
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