The Long Straddle Strategy is applied if a stock or index is likely to be highly volatile but not in a known direction. It entails the purchase of both a call and a put option with the same strike price and expiry. It profits from significant price movement in either direction—either way, a significant rise or fall in price, one of the options will be profitable.
How a Long Straddle Strategy Works
A long straddle is useful when a big news like an earnings report is expected to impact the prices of a stock. The traders buy a call option which gives them profit if the price goes up and a put option which helps them gain benefits when the prices go down. If the price moves significantly the profit from one option can cover the cost of both the options hence leading to a gain. If the stock price remains unchanged, the trader might lose the premium paid for both the options.
Benefits of a Long Straddle Strategy
Following are some benefits of implementing a Long Straddle Strategy:
- Profits from Volatility: The strategy is aided by robust price fluctuations in either direction.
- Limited Risk: The biggest loss is the initial premium cost of the options.
- No Need to Forecast Direction: The trader needs to only forecast volatility, not the direction of the move.
Conclusion
A long straddle strategy is ideal for a situation where the stock is expected to show some significant price movement due to an upcoming event. The risk is limited to the premium that is paid. The potential profit here is high. If market volatility is expected but the direction is not known, this strategy could be a useful approach.