Investors abhor a two-side market. Volatile conditions in the market give them an experience of a roller coaster. They helplessly see their portfolio move up and down. However, there is a silver lining to every cloudy condition. Many traders dream of volatile markets because they don’t care if condition is bullish or bearish. They just know it is headed somewhere.
Straddle is the most profitable strategy, when you expect considerable movement in a few days. If the move has already happened like announcement has been made then options are extremely expensive, so stay away from using this strategy.
Straddle options strategy includes purchase of two options.
- Call option, when strike is close to existing market price
- Put option with same strike price as call above
This means you invest two premiums. You can understand the straddle concept in the following way.
- If value increases considerably then the call option profits will counterbalance the put losses and you can earn profit
- If value decreases significantly then the put option profits will offset the call losses and you are left with some cash
If the value does not move at all or stays on the same price till expiry then you lose money. You will lose both the option premiums and this is known as theta decay. It is the worst side of straddle option strategy. However, maximum lose occurs rarely.
When is straddle deep in money?
Let’s understand straddle option in-depth using an example.
The stock price of Company J&J is currently $50. It’s half yearly earnings report is going to be announced in a week. You believe the stock to experience high volatility and buy straddle option expiring in 3 weeks.
As soon as, Company J&J releases the news, their share prices rise by 30% that is $65, then the straddle is regarded as deep in money as the stock price has increase $15 ($65-$50) over strike price. It puts call option profitable.
You desire to hold this straddle position till expiration because you feel this momentum to escalate. In a few days, another announcement is made by the Company J&J related of being investigated. It affects the stock price, which drops to $30. Under this scenario, your straddle position will still be regarded to be deep in money because your put option has increased by $20 ($50-$30) over strike price.
How to mold straddle options into directional trades?
If your preconception and expectations change, you can mold the direction of the options. If you started with straddle strategy then –
- As soon as you notice 1% move upwards and believe it to go higher then sell your ‘Put’ and hold ‘Call’.
- As soon as you see 1% movement downwards and feel the market to plummet then sell your “Call’ option quickly and hold ‘Put’.
When you change the strategy, your amount of profit and loss can change. Directional trades can be risky because bet is made on prices direction. Straddle bets on both directions. It is a huge difference. It is necessary to know when, where or why you need to get in or out or adjust.