The straddle is a two-legged options trading strategy that's designed to capitalize on high volatility. To construct a straddle, the trader buys to open a call and a put on the same stock, with the same strike price and expiration date. Essentially, the speculator has initiated simultaneous bullish and bearish trades, allowing the straddle to return a profit no matter which direction the underlying stock moves.
So, why isn't it a good idea to play a straddle on every stock, every time, just to guarantee a winning trade? Because two options are purchased instead of one, the breakeven point on a straddle is significantly higher (or lower, on the put side) than with a single-option strategy. As a result, the equity needs to make a major directional move to offset the higher cost of entry -- a modest uptick or pullback isn't going to cut it.
Plus, if the stock moves sideways through expiration, the straddle buyer may incur a nearly 100% loss on both options, whereas a straightforward call or put buyer would be out the cost of only one option.
While they're not ideal for every trading scenario, however, straddles can be a very profitable strategy when the underlying stock is expected to experience a significant rise in volatility during the time frame of the trade.
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