The Straddle Trading Strategy

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Straddle Options Trading Strategy Using Python

Introduction

The purpose of this article is to provide an introductory understanding of the Straddle Options in Trading and can be used to create your own trading strategy.

What Is Straddle Options Strategy?

How To Practice Straddle Options Strategy?

Types Of Straddle Options Strategy

Long Straddle

Straddle Options Strategy works well in low IV regimes and the setup cost is low but the stock is expected to move a lot. It puts the Long Call and Long Put at the same exact Price, and they have the same expiry on the same asset. This is unlike that in the Strangle options trading strategy where the price of options varies.

The strategy would ideally look something like this:

Straddle Options Strategy Highlights

It can be done by either of these methods:

  • In The Money Call Option
  • In The Money Put Option

Maximum Loss: Call Premium + Put Premium

Breakeven

At expiration, if the Strike Price is above or below the amount of the Premium Paid, then the strategy would break even.

In either case of Strike Price being above or below,

  • the value of one option will be equal to the premium paid for the options, and
  • the value of the other option will be expiring worthless.

It can be described as below:

  • Upside Breakeven = Strike + Premiums Paid
  • Downside Breakeven = Strike – Premiums Paid

How To Profit From Straddle Options Strategy?

Now, if the market moves by less than 10%, then it is difficult to make a profit on this strategy. The Maximum Risk materialises if the stock price expires at the Strike Price.

Implementing The Straddle Options Strategy

Traders benefit from a Long Straddle strategy if the underlying asset moves a lot, regardless of which way it moves. The same has been witnessed in the share price of PNB if you have a look at the chart below:

Last 1-month stock price movement (Source – Google Finance)

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There has been a lot of movement in the stock price of PNB, the highest being 194.65 and lowest being 117.05 in last 1 month which is the current value as per Google Finance and an IV of 18.25%

For the purpose of this example; I will buy 1 in the money Put and 1 out of the money Call Options.

Here is the option chain of PNB for the expiry date of 29th March 2020 from Source: nseindia.com

I will pay INR 16.05 for the call with a strike price of 110 and INR 8.30 for the put with a strike price of 110. The options will expire on 29th March 2020 and to make a profit out of it, there should be a substantial movement in the PNB stock before the expiry.

The net premium paid to initiate this trade will be INR 24.35 hence the stock needs to move down to 85.65 on the downside or 134.35 on the upside before this strategy will break even.

Considering the massive amount of volatility in the market due to various factors and taking into account the market recovery process from the recent downfall we can assume that there can be an opportunity to book a profit here.

How To Calculate The Straddle Options Strategy Payoff In Python?

Import Libraries

Call Payoff

The payoff should ideally look like this:

Put Payoff

Straddle Payoff

Short Straddle Options Strategy

Conclusion

In this article we have covered all the elements of Straddle Options Strategy using a live market example and by understanding how the strategy can be calculated in Python.

Next Step

Disclaimer: All investments and trading in the stock market involve risk. Any decisions to place trades in the financial markets, including trading in stock or options or other financial instruments is a personal decision that should only be made after thorough research, including a personal risk and financial assessment and the engagement of professional assistance to the extent you believe necessary. The trading strategies or related information mentioned in this article is for informational purposes only.

Options Straddle Strategies & Earnings Events: What Are the Risks?

Can straddles be used in an options strategy around earnings announcements or other market-moving events? Yes, but there are risks and other considerations.

Key Takeaways

  • A long straddle options strategy seeks to profit from a large price move regardless of direction
  • Straddles and other options strategies may sometimes be considered useful around earnings announcements, when volatility may be high
  • Know the risks of trading options around earnings reports, including the chance of a volatility crush

Some traders think a stock’s going to make a move, perhaps because of an earnings announcement or other upcoming event, then they consider buying a call option in case it goes up and a put option in case it goes down. This options strategy is known as a long straddle, and the idea is for the underlying to make a large move in either direction, so the straddle price expands beyond what was paid for it.

It might sound like a rational plan. But there’s a little more to consider.

Ways to Potentially Profit or Lose from a Long Straddle

Again, the idea of a long straddle is to gain from a large move without picking a direction. The position is created by buying an at-the-money (ATM) call and ATM put with the same strike price in the same expiration cycle. There are a couple different ways this strategy might see gains.

First, the long straddle could profit if the underlying stock moves significantly. If it moves higher, the call option may profit by more than the put option loses, potentially netting a profit after transaction costs. Conversely, the put option may outperform the losses from the call if the stock drops far enough before expiration.

It’s not just a matter of the stock moving, but also the magnitude of the stock’s movement. It needs to move far enough to overcome the price paid for the straddle, in addition to the transaction costs.

Another way long straddles can profit is if there’s a rise in implied volatility (vol). Higher implied vol can increase both call and put options prices, just as lower vol can decrease both the put and call prices (which would typically lead to a loss). Even if vol were to stay the same, the trade can lose, as option prices tend to decay with the passage of time.

So even if there is a rise in implied vol, it has to be a big enough difference to offset the time decay (“theta”) subtracted from both options. Vol and time decay, as we’ll see, can play a major role in whether a straddle is a winner or a loser.

Earnings announcements, or other known events (such as the introduction of a new product or ruling on a court case) are the types of events in which a long straddle trade might be placed. What’s important to keep in mind is that the straddle is pricing in the “normal” volatility days plus the heightened “event day volatility.” As you get closer to the event, there are fewer normal vol (lower) days, so the higher event day vol has more influence. This is why the implied vol usually rises leading into the event.

Beware the Vol Crush Post-Event

Holding on to a straddle through an event can be risky (see figure 1). Because volatility plays a big part in a straddle, it’s imperative that the straddle is bought at a time when vol is near the low end of its historical range. In figure 1, holding a straddle after the earnings announcements (marked by the red phone icons) could have been problematic if the post earnings move was not large enough to make up for the steep drop in vol. Notice how vol in the lower pane of the graph rose going into the earnings announcement, but regressed to its long term average following the event.

FIGURE 1: VOLATILITY AROUND EARNINGS ANNOUNCEMENTS. Volatility tends to rise ahead of a company’s earnings announcement and then tends to fall after the event has taken place. Data source: Cboe. Chart source: the TD Ameritrade thinkorswim ® platform. For illustrative purposes only. Past performance does not guarantee future results.

How Big of a Move Is Expected? See the MMM

Selling a Straddle or Iron Condor Ahead of Earnings

If you feel that the premium levels in the options are elevated enough to make up for a post-event move in the underlying, then selling a straddle ahead of the announcement might make sense. It’s important to remember, though, that selling a straddle entails open-ended risk. The maximum profit is capped at the strike, and it begins to erode the further the underlying moves away from it. Eventually, the profit turns to a loss, with no limitation on the upside. On the downside, the loss is capped only when the underlying stock goes to zero (see the short straddle risk graph below).

One potential alternative is a short iron condor. It’s a four-legged spread constructed by selling one call vertical spread and one put vertical spread simultaneously in the same expiration cycle. Typically, both vertical spreads are out of the money and centered around the current underlying price (see the iron condor risk graph).

The iron condor strategy is a favorite of many option traders as a way to take advantage of higher-than-typical implied vol, such as before an earnings release. Note that, unlike the short straddle, the iron condor’s risk is defined by the difference between the strike prices of the verticals minus the credit received when selling the iron condor. For example, if the verticals are $2 wide and the iron condor is sold for an $0.80 credit, the risk is $1.20 per contract before transaction costs.

The iron condor strategy is typically considered by traders who believe the current vol is elevated, they expect vol to drop once the news is out, and if they believe the price of the underlying will remain between the two short strikes in the iron condor (or at least close). But one reminder about an iron condor: This spread has four legs, which means extra transaction costs.

There’s no right or wrong way to play earnings and other company announcements; much depends on your objectives, risk tolerance, and the your view of the market. Long options straddles can be an effective way to trade the lead-in to earnings, but traders might also consider short options strategies going into the release. Just make sure you know and are comfortable with the risks involved.

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Long Straddle Overview

Kevin Ott

The long straddle option strategy is a neutral options strategy that capitalizes on volatility increases and significant up or down moves in the underlying asset.

Another way to think of a long straddle is a long call and a long put at the same exact strike price (in the same expiration series on the same asset, of course). Although many options strategies capitalize on the passage of time, the long straddle is not one of them. Dramatic moves in either direction or sharp volatility spikes are needed for long straddles to be profitable trades. Not to be confused with the long strangle, which involves calls and puts of different strike prices, the long straddle only involves the same strike price options.

Key Points

  • If you purchase a call and a put of the same strike price, it’s considered a long straddle
  • Long straddles lose money every day due to theta decay
  • Traders usually buy straddles ahead of earnings announcements or binary events, like an FDA announcement
  • Long straddles will be profitable with volatility expansion or dramatic up/down moves in the underlying asset
  • Long straddles are typically traded at or near the price of the underlying asset, but they don’t have to be
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Long Straddle Option Strategy Definition

-Buy 1 call (same strike price)

-Buy 1 put (same strike price)

Note: Long straddles are always traded with the exact same strike price. If the long call and the long put are different strike prices, it is considered a long strangle.

Long Straddle Example

Stock XYZ is trading at $50 a share.

Buy 50 call for $0.30

Buy 50 put for $0.30

The net amount spent for this trade is $0.60 ($60), the premium from both long options positions.

The best case scenario for a long straddle is for the underlying instrument to completely crash down or surge up. When this happens, volatility tends to expand, and the straddle benefits. If stock XYZ doesn’t budge, the long straddle is going to lose money due to premium decay.

Long Straddle Details

Maximum Profit Unlimited
Maximum Loss Premium spent
Risk Level Low
Best For Anticipating a significant up or down move in a stock
When to Trade Before earnings announcements, FDA deadlines, etc.
Legs 2 legs
Construction long call + long put
Opposite Position Short straddle

Maximum Profit and Loss for the Long Straddle Option Strategy

Maximum profit for a long straddle = UNLIMITED

Maximum loss for a long straddle = PREMIUM SPENT

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.

Break-Even for the Long Straddle Option Strategy

There are two break-even points for a long straddle.

The upside break-even point = long call strike + premium spent.

The downside break-even point = long put strike premium spent.

Why Trade Long Straddles?

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. The rationale behind placing a long straddle is that the underlying asset is probably going to move sharply in either direction, it’s just too difficult to predict which way it will go.

Margin Requirements for Long Straddles

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.

What about Theta (Time) Decay?

Theta decay for a long straddle is not beneficial at all. If the underlying asset (like a stock, futures contract, index, etc.) doesn’t move at all before expiration, long straddles will lose money because of premium decay. This means timing is very important. If the underlying asset moves after expiration, it won’t do any good.

When Should I close out a Long Straddle?

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 the position is unprofitable, and the option premium has neared zero, there is no reason to close out the trade. There is always a chance that the underlying asset can move dramatically, or volatility can increase, and make the trade profitable again.

Anything I should Know about Expiration?

Yes! Due to the fact the fact that straddles are always traded at the money, either the call or the put is going to expire in-the-money. It’s impossible to both options to not expire ITM.

However, this is not to say that both options cannot expire almost worthless; the long call can expire worthless and the long put can expire with an intrinsic value of $0.01.

Because one leg of a straddle will always expire ITM, this options trading strategy needs additional attention around the time of expiration.

If a long put expires ITM, a margin call could be issued if there is not enough cash in your account to short the appropriate amount of the underlying security at the strike price. Similarly if the long call expires ITM, a margin call could be issued if there is not enough cash in your account to buy the underlying at the strike price.

All potential expiration predicaments with long straddles can be fully avoided by checking expiring options positions the day before and the day of expiration. Depending on your options broker, you will usually be notified of expiring positions that are ITM.

Important Tips for Selling Straddles

On the surface, long straddles seem like the perfect options trading strategy. Who knows if a stock is going to move up or down? Chances are, it’s going to move one way or the other…unless it doesn’t. The only way the long straddle option strategy will not be profitable is if nothing happens prior to expiration, or if volatility collapses.

Therefore, long straddles are very interesting trades for volatile markets with large price swings.

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