Learn to Trade Options: The Triple-Digit Profit Power of Straddles

Breaking down straddles with options guru, Bernie Schaeffer

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    Trading options can be a complicated process as a lot of options strategies are available and traders need to evaluate all of the possible routes ahead of executing a trade. As such, Schaeffer's are starting a new educational series titled Optimizing Your Options Strategies. The beauty of options trading is that there are options strategies for every market environment. In this series, we will cover all available options strategies for an educated trader to consider when identifying trading opportunities.

    In this article, we will be talking about one of the most popular options strategies known as Straddles. A straddle is a net-neutral options trading strategy where the trader simultaneously buys both a put option as well as a call option for the underlying stock with the same strike price and the same expiration date.

    Traders profit from a straddle trade when the price of the underlying stock rises or falls from the strike price by a significant amount more than the total cost of the premium paid. It does not matter which direction the underlying stock goes, as long as the move is significant. Profit potential from straddle buying is theoretically unlimited if the price of the underlying stock moves sharply.

    How Does Straddle Trading Work?

    In options trading, straddle strategies involves two separate legs of a transaction that involve the same underlying asset with the two options offsetting one another. Traders use straddle as the options strategy of choice when they anticipate a significant move in a stock, but do not know that it will go up or go down. Generally, there are two types of straddle options strategies used by traders.

    A long straddle is designed around a purchase of put and call options at the exact same strike price and same expiration date. The long call strategy is designed to take advantage of the market price change if the volatility increases. A long straddle will benefit if the underlying asset goes in any direction, so the stock can go in any direction and you come out profitable.

    A short straddle is designed around a trader selling both a put and call option at the same strike price and same expiration date. By selling the options, the trader can collect a premium from both the options as profit. A trader only profits with a short strangle options strategy in a market with little or no volatility. The opportunity to profit is based on the market's lack of ability to move the price of the underlying asset either up or down. If the price of the underlying asset moves in any direction, then you can theoretically have an unlimited loss.

    The Risk and Reward of Implementing Straddle Options Strategies

    For long straddle buys, the profit potential is unlimited because the underlying asset price, in theory, can rise indefinitely while on the downside, the profit potential is also substantial as the underlying asset price can fall to zero. For long straddles, the potential maximum loss is limited to the total cost of buying both the call option as well as the put option plus the fees and the commission involved. A loss is realized if the position is held till expiry and both the call and put options expire worthless (out-of-the-money). Both the options will only expire worthless if the price of the underlying asset does not move at all till the time of the expiry.

    For short straddle buys, the profit potential is limited to the premium received from selling both the call and put options minus the fees and commission. The maximum profit is earned if the short straddle is held to expiration and the stock price is the same strike price at expiry and both the options expire worthless. For short straddles, the potential loss is unlimited due to the nature of selling naked calls and puts. If the price of the underlying asset moves up, then the potential loss is unlimited because the underlying asset can theoretically rise indefinitely. On the downside, the potential

    For both long and short straddle buys, there are two potential breakeven points due to the nature of the strategy. For  buying straddles, the breakeven points can be found out by calculating 1) the strike price plus total premium and 2) strike price minus the total premium.

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