Straddle (Options Trading) Definition
A straddle is an options trading strategy. A trader buys/sells the Call and Put options for the same underlying asset simultaneously at a certain point in time to use a straddle, provided both options have the same expiry date and strike price. If the price movement is not clear, a trader joins such a neutral trading mix. If the two competing trading schemes collapse, losses can be offset in an ideal situation. A straddle strategy in finance refers to two transactions, with positions that share the same security and offset one another. While one has a short risk, the other has a long risk.
A Little More on What is a Straddle in Options Trading
The straddle option is a volatility strategy. It’s one of the most useful indicators around, even if you never trade it. You can see that the straddle is pricing traders for future volatility estimates, its implicit volatility, unlike historical volatility measured in past stock price statistics.
The implicit volatility is how the public recognizes a future security campaign. This is a crucial metric investor often used to predict shifts in future security rates.
In other words, marketplaces think best about where a certain stock or ETF is going to sell by using a straddle.
Furthermore, by the expiry date, the estimated trade range of the stock can be determined with a straddle.
Putting Together a Straddle Position
The prices of the pull and call must be summed up in order to determine how much it costs to create a straddle. For instance, following earnings on March 1, if a trader speculates the rise or fall of a stock from its current price of $55, the trader can decide to bring a straddle into creation. One put and one call can be bought at a strike of $55 and an expiry date of March 15 by the trader. The prices of one $55 March 15 call and one $55 March 15 put will have to be summed up by the trader in order to arrive at the amount it costs to create a straddle.
Determining the Expected Volatility
When an event occurs in the economy, such as the announcement of earnings or the presentation of the annual budget, market volatility rises before the announcement is made. Traders usually buy stocks from businesses that are about to make earnings. Some traders sometimes use the straddle strategy too early, which can improve the options for ATM calling and ATM putting and make them very expensive to buy. Before such a situation arises, traders have to be assertive and exit the market. Division of the $5 premium paid by the $55 strike price is used to determine how much the stock needs to rise or fall.
Discovering the Trading Range
In order for the trader to arrive at a range the stock is expected to be at, the trader would be required to reduce the strike price of $55 by a $5 premium (subtraction), or the trader can sum up the $5 premium with the $55 strike price (addition). The situation above will establish a $50 to $60 trading range. The trader is likely to lose a portion of his money, but not necessarily all of his money if the stock is finally traded within the range of $50 to $60. The trader can only earn a profit when the stock rises above or falls outside the $50 to $60 trading range.
Earning a Profit
The worth of the calls would be $0 while the worth of the puts would be $7 on the expiry date if peradventure the stock falls to $48. This would mean that the trader will accrue a profit of $2 from the trade. In a situation where the stock rises by $57, the worth of the calls would be $2 while the worth of the puts would be $0 on the expiry date. This would mean that the trader will lose $3 from the trade. The most terrible situation which can be encountered by the trader is one where the price of stocks remains at or moves close to the strike price.
- A straddle is an options trading strategy where a trader buys/sells the Call and Put options for the same underlying asset simultaneously at a certain point in time.
- A trade is eligible to be termed a straddle if a call or put options can be purchased, the options are part of the same security, both trades have the same strike price and expiry date.
- The straddle strategy is said to be profitable when there is a rise or fall of stock by more than the total premium paid, from the strike price.
- What a security’s expected volatility and trading range maybe by its expiry date is indicated by the straddle.
Real World Example of a Straddle
It cost $5.10 to purchase one put and one call from AMD’s stock on the 18th of June, 2019. This gave AMD an indication that its stock could have a 20% rise or fall from the current $26 strike price which would be expiring on the 16th of July, 2019 in the options market. Its stock was placed within a $20.90 to $31.15 range. On the 23rd of July, 2019, exactly one week after determining the stock range, its shares fell from $22.70 to $19.27 when AMD gave company reports. This scenario shows that AMD made a profit due to the fact that the stock fell outside the trading range.