Introduction
“Long Straddle Strategy” is one of the strategies you can use in “Options Trading” to manage your risk in this high-risk market and make a profit. Options trading is one of the most popular financial markets around the globe, which is attracting many users every day. Although this marker is too risky, some strategies can help you reduce the risk and increase your winning ratio. It all depends on your personal goals and character. If you seek to trade Options and make income through this business, this article is the best for you as it introduces the “Long Straddle Strategy” and how you can use it effectively through your journey to becoming an Options Trader.
What Is a Long Straddle Options Strategy?
A “Long Strangle Strategy” is to buy a long call and put an option at the same time. In this strategy, the fundamental assets, strike price, and expiration date of both options are the same. The “Long Straddle Strategy” is a neutral strategy which seeks to profit from the highly volatile market when investors believe that price movements can be significant and could fall or rise significantly. This volatility will likely develop in the context of budget declarations, company results or important market-related news and events.
The “long straddle options strategy” is a bet on a significant change in price for the underlying asset, either higher or lower. No matter how the asset swings, the profit profile remains the same. Usually, the trader believes that the upcoming release of fresh information will cause the underlying asset to change from a low-volatility state to a high-volatility state. The special price is at or near the money as possible. Both of these components cancel out modest swings either way because a call option profits from an increase in the underlying asset’s value, while a put option results in a gain when the value decreases. Therefore, the primary purpose of a long straddle is to profit from a decisive move in either direction by the underlying asset, typically caused by a newsworthy event.
How to Use a Long Straddle Strategy in Options Trading?
Traders may use the long straddle before a news report like an earnings announcement, Fed action, passage of lawmaking or election results. They believe that the market will wait for such an event, leading to uncertainty in trading within a narrow range of prices. As soon as the event occurs, all pent-up bullishness or bearishness will flow out and lead to a swift movement of the underlying asset.
The traders are still determining whether to be a bull or a bear, as the actual event has no apparent result. Therefore, the logical Strategy for making money from both outcomes is a long straddle. However, as with any “investment strategy”, there are challenges to be met by a “long straddle”. Later in this article, we will discuss all the potential challenges and risks associated with this Strategy.
What Are the Risks of the Long Straddle Strategy?
The primary and foremost risk inherent in the “Long Straddle Strategy” is that the market does not react sufficiently to an event or the news it produces. The fact that options traders know an event is approaching increases the price of put and call options as they prepare. Therefore, if no significant news event were likely to occur, the cost of a strategy attempt would be much higher than merely betting in one direction alone and more costly than betting in both directions.
Why Does a Long Straddle Strategy Fail?
Since option buyers know the added risk associated with a planned news event, they’re raising prices to meet what they think is about 70% of anticipated events. This will significantly impact traders because, since the straddle’s price already consists of moderate moves in either direction, they are much less likely to benefit from this move. Suppose the anticipated event does not lead to a material movement in either direction for the underlying asset. In that case, options bought can expire worthless and may result in losses incurred by the trader.
How the Long Straddle Strategy Works?
Before knowing how this Strategy works, there are some special terms which you should be familiar with them. In the following, the most important terms related to the Long Straddle Strategy are listed:
- Strike Price: The investor will choose the strike price, significantly impacting the asset’s intrinsic value.
- Expiry date: the investor chooses an expiry date that expects the underlying asset’s price to be volatile in that duration.
- Volatility: High volatility of the underlying asset price is required to achieve a successful long-straddle strategy. Through this Strategy, an investor’s goal is to make money on significant price movements, regardless of how high or low they rise.
- Breakeven Point: The point at which the total cost of both options has been recovered is called a breakeven point in this Strategy. This occurs when the underlying asset’s price is higher than the strike price plus the total cost of the options or is lower than the strike price minus the total cost of the options.
Now that you are familiar with the terms let’s talk about the function of the Long Straddle Strategy in advance. The Long Straddle Strategy includes two steps, which are explained below:
- Step 1: Buying a Call Option: within an expiration period, the investor shall purchase a call option in which he has the right to buy that underlying asset at a specified strike price. When the price of an asset rises above its strike price, a call option profits.
- Step 2: Buying a Put Option: At the same time, an investor buys a put option that gives him the right to sell his assets at their strike price within the same expiry time. The put option will be profitable if the underlying asset’s price is below its strike price.
Next, in this article, you are provided with an example of the Long Straddle Strategy, which helps you to understand the function of this Strategy deeply.
Long Straddle Strategy Example
Imagine a stock’s worth is $50 per share. There is a call option with a strike price of $50 for $3, and a put option with the same strike is also $3. The investor buys one of each option and enters into a straddle. Accordingly, the option sellers expect a 70% probability of stock movement at $6 or less in either direction. But when the shares trade above $56 or lower than $44, regardless of their initial price, this position is profitable at expiration.
What is the Best Long Straddle Strategy?
There is no concept as the best Long Straddle Strategy since there is only one way to trade this way (as we explained above). This Strategy involves high risk and has advantages and disadvantages, which we will explain later. Keep in mind that you must be experienced and take some educational courses before you start trading using the Long Straddle Strategy.
Are There Any Alternative Uses of the Long Straddle Strategy?
Many traders suggested that capturing an expected rise in implied volatility is more suitable for using Long straddles. They would start this strategy at least three weeks or more before the event happens and close it in advance if they were profitable. This approach aims to use the rising demand for options itself, which raises the implied volatility component of those options.
Therefore, increasing implied volatility in all puts and calls at any strike price is a significant factor that will make option prices more volatile over time. The directional risk from the Strategy can be removed by holding a put and call, leaving only an implied volatility component. Therefore, it should be profitable if the trade is initiated before increasing implied volatility and terminated as it reaches its peak.
However, the natural tendency for options to be depreciated due to time decay is a limitation of this other method. To overcome this natural decrease in prices, it is necessary to select options with expiry dates that are not likely to be affected too much by time decay, also known to options traders as theta.
What Are the Merits and Demerits of the Long Straddle Strategy?
Like any other Strategy in the financial markets, the Long Straddle Strategy also has its own advantages and disadvantages. Knowing the pros and cons helps the investors understand what they may face, and therefore, they can make better decisions. The following actual merits and demerits of this Strategy are listed:
Advantages:
- The Long Straddle Options Strategy is Neutral, meaning the market direction will not influence it.
- Even when the price movement is negative or in a highly volatile market, the Long Straddle Strategy gives investors an enormous profit margin.
- Holding the straddle until expiry reduces the risk of losing its entire cost.
- Long Straddles are generally less sensitive to time decay than other Straddles.
Disadvantages:
- Implementing the Long Straddle Option Strategy can be costly as purchasing in-the-money options is more expensive than buying out-of-the-money options.
- Implementing the Long Straddle Strategy can be difficult and requires high expertise for its execution and profit making.
- The market’s volatility can become difficult to detect, leaving a long straddle strategy useless, as markets can follow a particular trend.
- As it costs too much, investors will buy fewer straddles and thus limit their profit potential.
Know that you have learned the Long Straddle Strategy, you need to spend more time on practice. If you find yourself still capable of learning, do not forget to take some tutorial courses before starting trading in the Options Trading Market, and after that, test your trading strategy in a “Demo Account” to ensure whether it works for you. CloseOption is one of the trusted Options Trading Brokers that offers a Free Demo Account to all its users.
By using CloseOption’s free demo account, you can gain experience and test your trading strategy in a real-time trading area. You can start with a $ 10,000 virtual account and recharge it for free whenever you run out of balance. All the options, features and prices are exactly the same as the real account, and you will feel no difference trading in the demo account.
CloseOption’s demo account is designed according to the traders’ needs. Whether you are a novice trader or a professional, CloseOption’s platform can meet your needs at any time. You can sign up for free by clicking Here.
Conclusion
A Long Straddle Options Strategy may be a bit difficult to implement, but once you become a master of this strategy, you will find it to be one of the most effective strategies that can be used in volatile markets. In such a situation, the Long Straddle Strategy can cope with volatility and generate better returns than the bull market because every investor fears losing money. Nonetheless, all investors should be cautious due to the risk of losing a large amount of money. Once you have gained enough knowledge and experience about this strategy and become aware of all the pros and cons, you can start using it to make profits.
