Long Straddle Options Strategy (Best Guide w/ Examples!)

[Music] hey everybody Chris here from project option and in today's options trading strategies video we're going to talk about the long straddle now the long straddle strategy profits when the stock price makes a significant movement in either direction or when implied volatility increases so in this video we're going to talk about the general characteristics of the long straddle and then we're going to talk about the expiration risk profile graph and then we're gonna finish off with a couple real long straddle trade examples so that you can see how the position performs in various scenarios so let's dive right in alright so buying straddles or sometimes referred to as a long straddle is an option strategy constructed by buying a call and put option at the same strike price and in the same expiration cycle now most of the time the at the money strike price is used now the maximum profit potential of a long straddle is theoretically unlimited because you do own a call option and there's no limit to how high a stock price can rise now the maximum loss potential for long straddle is the debit paid at time is 100 so if you pay $10 in premium for a long straddle then your maximum loss potential is $10 times 100 or 1,000 dollars per long straddle now the maximum loss is a very rare scenario because that only happens when the stock price is right at your long straddle strike price so most of the time a long straddle will expire with some intrinsic value but you know there could still could be a substantial loss there if the stock price does not move away from that strike price so the expiration breakeven prices are going to be the strike price plus the debit paid and the strike price minus the debit paid so to make money on a long straddle at expiration the stock price has to have moved more than the debit you paid away from the straddle strike price now it doesn't matter if that movement is up or down now since you need a large stock price movement to profit with a long straddle the estimated probability of profit is less than 50% now the resulting position after expiration it depends on if the long call or the long is in the money so if the long call is in the money at expiration then a long straddle will expire two plus one hundred shares of stock per call option that you have now if the long put is in the money at expiration then the position will expire to negative 100 shares of stock per long put so that's essentially a short stock position of a hundred shares per put that you own now since a long straddle does not include any short option components there is no early assignment risk all right now let's apply those general characteristics to a hypothetical long straddle position so at the time of these option prices let's say the stock price is trading at two hundred and fifty dollars and we believe the stock price is going to make a significant move in either direction so to construct a long straddle position we're going to buy the 250 put for fifteen dollars and ten cents and we're going to buy the 250 call for fifteen dollars and 20 cents now that's going to bring our net debit to 30 dollars and thirty cents so let's go ahead and take a look at the expiration risk profile graph for this position okay so as you can see here we bought the 250 straddle for 30 dollars and 30 cents and as we can see based on this graph that our maximum loss potential is three thousand and thirty dollars now that comes from the thirty dollar and thirty cent debit we paid times 100 so if the stock price is right at 250 at expiration both the long put and long call that we purchased will expire worthless and we'll lose the entire debit that we paid now our breakeven prices in this example are going to be the strike price of 250 plus the debit paid and the strike price of 250 minus the debit paid so our lower breakeven price is to 1970 and our upper breakeven price is 280 30 and lastly we can see that there's significant profit potential when the stock price increases or decreases significantly so when you buy a straddle you're betting that the stock price is going to make an outsized move and if it does not then you will lose money from time decay as time passes because those long options that you own will be losing their extrinsic value all right so now that you've seen the expiration risk profile graph and the general characteristics of the long straddle strategy let's go ahead and take a look at the Greek exposure so that you can understand how the position is expected to perform before it expires so in general the Delta of the long straddle will begin at 0 because most of the time people will buy and at the money straddle and that means the call Delta and the put Delta will be offsetting each other and you'll have virtually no directional exposure however you can structure a long straddle in a directional manner by purchasing an out of the money strike price now that's not very common because generally a long straddle is entered with a market neutral bias and you want the stock price to move significantly away from the strike price that you buy now in terms of gamma and long straddle has positive gamma and that's really what drives the profits of the strategy so positive gamma means that when the stock price rises a long straddle becomes more directionally long and that means you want the stock price to continue upwards because now that you have a positive Delta you'll start to make money if the stock price continues to rise now when the stock price Falls a long straddle position becomes more and that's because the position Delta gets more and more negative now that means you want the downside price action to continue because with your negative Delta you'll make money if the stock price continues to decrease now in regards to theta a long straddle theta is negative and that means that the extrinsic value of options decays over time and that leads to decreasing option prices which is obviously not what you want when you buy a straddle so if the stock price sits right at your long strike as time passes you're going to lose money from time decay because the extrinsic value of the options that you own is decreasing now lastly Vega is positive for a long straddle position because you'll make money if implied volatility increases and that's because an increase in implied volatility indicates that option prices are increasing which is obviously what you want as an option owner now on the other hand decreases an implied volatility indicate that option prices are falling which means that you'll be losing money from owning that straddle so when you put all these Greeks together we learned that a long straddle position profits in two ways the first being a significant stock price movement in either direction and the second being an increase in implied volatility now a long straddle can also lose money in two ways and that's primarily from the passage of time from that negative theta but you can also lose money if implied volatility decreases so now let's go ahead and get into some example trades to show you how the long straddle strategy performs in various scenarios so the first example we're going to look at is where a long straddle incurs a big loss now that happens when the stock price is near the strike price that you purchase at expiration so here's the setup the initial stock price is two hundred and ten dollars and seventy two cents initial implied volatility is fifteen percent and we're going to buy the two eleven put and the two eleven call that expire in seventy seven days now for the straddle we're going to pay a net debit of nine dollars and seventy eight cents and that's going to bring our upper breakeven price to two twenty seventy eight and our lower breakeven price to 201 twenty two so those breakeven prices come from the straddle strike price plus the debit and the straddle strike price minus the debit now our maximum profit potential is theoretically unlimited and the maximum loss potential is the debit paid which is nine dollars and seventy eight cents times 100 which is nine hundred and seventy eight dollars per straddle so let's go ahead and see what happens to this position over time all right so on the top part of this graph we're looking at the straddle strike price of two hundred eleven dollars and we can see the upper breakeven price and the lower breakeven price and on top of all that we see the changes in the stock price so in the bottom part of the graph we're looking at the entry price of our long straddle and then we're looking at the changes in that straddle price as well as any corresponding profits or losses so when the straddle price increases from our point of entry we have profits and when the straddle price decreases from our point of entry we have losses so in this example we can see that the stock price remains right around our strike price of 211 over the entire seventy seven day period now on the bottom part of the graph we can see that the straddles price steadily loses value now that's from that negative theta that we talked about so as the stock price remains that remains around 211 as time passes the 211 call in the 211 put are losing extrinsic value and that leads to a cheaper and cheaper straddle price which leads to losses for us so unfortunately in this case the straddle incurred a large loss and you know at expiration it was worth you know right a dollar 25 or a dollar 50 which means we pretty much lost 85 to 90 percent of what we paid for this straddle now it is important to note that at expiration that long to 11 call is in the money and that means if this position was held through expiration that long call would expire to plus 100 shares of stock so you would buy a hundred shares of stock at that 211 strike price so if you did not want a stock position after expiration you'd have to close that long call before it expires alright so let's look at example trade number two a break-even long straddle so here is the setup the initial stock price is 210 56 then we're going to buy the 211 put in 211 call that expire in 60 days now the net debit we're gonna pay for this trade it's eight dollars and thirty four cents and that's going to bring our upper breakeven price to two 1934 and our lower breakeven price to 202 66 now our maximum profit potential is unlimited and our maximum loss potential is the amount we paid of eight dollars and 34 cents times 100 and that comes out to eight hundred and thirty four dollars per long straddle so let's go ahead and take a look at what happens to this position over time alright so in the top part of the graph we're looking at the changes in the stock price relative to our straddle strike price and breakeven points and in the bottom part of the graph we're looking at the price changes of that 211 straddle so as we can see right after we bought that 211 straddle the stock price fell down to around 185 dollars and at the same time that straddle price rose from eight dollars and 34 cents all the way up to 25 dollars so the straddle price tripled now in this particular case the stock price did recover and rallied all the way back to our lower break-even price of 200 266 at the time of expiration so if the trader who bought this straddle did not lock in their profits early on this trade then they would have just broke even at expiration which is not a bad outcome at all so since that 211 long put was in the money at expiration keep in mind that this position would expire to negative 100 shares of stock per long put so if you didn't want a short stock position after expiration you'd have to go ahead and sell that long put before it expires so this example is actually a good demonstration of how positive gamma works for a long straddle position so at the time of buying the straddle the position Delta was right around zero which means we essentially had no exposure to small changes in the stock price however as the stock price fell towards 185 that long puts Delta starts to grow more negative and the long calls Delta starts to decrease towards zero so the net effect of that is that the position Delta of the long straddle starts to grow more towards negative 100 now a delta of negative 80 means that if the stock price decreases by one more dollar we're expected to profit by $80 and that the stock price increases by one dollar we're expected to lose $80 so as we can see here if the stock price decreases away from our long straddle strike price our position becomes more short because our position Delta is negative now that means that we want the stock to continue to decrease because that's going to lead to more and more profits for a long straddle position now the opposite is true on the upside if the stock price starts to increase a long straddle position Delta will start to grow towards 100 for each long straddle and that's because the long call will be more and more in the money and the position Delta of that long call will approach plus 100 while the long puts Delta will approach zero so that means the long straddle position Delta will grow more towards plus 100 and that just means that we want the stock price to continue rising because will benefit more and more from a continuation of that move all right so in this final example we're gonna look at a collapsing stock price after a long straddle position is initiated and obviously that should be a good thing for a long straddle position because when you buy a straddle you need a large stock price movement in either direction so here's the setup the initial stock price is 126 20 and for our long straddle we're going to buy the 126 foot and 126 call expiring in 78 days now we're gonna pay a net debit of 10 dollars and 25 cents and that's going to bring our upper breakeven price to 136 25 and our lower break-even price to 115 75 now as always our maximum profit potential is unlimited and the most we can lose is the debit paid times 100 which is 1025 dollars so let's go ahead and see what happens to this position as the stock price moves through time all right so in the top part of the graph we're looking at the changes in the stock price relative to our straddles strike price and breakeven points and in the bottom part of the graph we're looking at the changes in the straddle price from our initial point of entry now as we can see here in the top part of the graph the stock price remains right around our strike price of 126 for the first 45 days or so and in the bottom part of the graph we can see that the long straddle is actually losing value over that time period now later on in the period before the straddle expires we can see that the stock price Falls from 126 all the way down to 85 dollars at the lowest point and while that move happens the straddle price increases from $10 all the way up to around $37 so as we can see here the stock the straddle price almost quadrupled over that period because the stock price made a significant movement that was not expected so this is just a great example of how when you buy a straddle you need the stock price to move in a very very significant way either up or down and that will lead to profits for a long straddle holder now in this case the profits came from not only that directional movement to the downside but also from an implied volatility increase so when a stock decreases in value rapidly it's option prices tend to expand quickly as well so both of those factors led to a profitable long straddle position in this particular case all right now let's quickly summarize the main concepts from this video so first and foremost buying straddles is a directionally neutral strategy that consists of buying a put and call option with the same strike price and expiration cycle now most of the time at the money options are used now the main profit drivers when buying straddles are increases in implied volatility because a long straddle has positive Vega or large stock price movements in either direction because a long straddle has positive gamma now since the stock price or implied volatility has to change significantly for a long straddle to be profitable riding straddles is a low probability trait now to close a long straddle before expiration the long call input can be sold at their current market prices to lock in profits or losses and lastly if the stock price is below the straddle strike at expiration the long put will expire to negative 100 shares of stock even if the stock price is above the straddle strike price at expiration the long call will expire to plus 100 shares of stock so if you don't want a stock position at expiration you're gonna have to close your long straddle before it expires thank you for watching this video everybody if you enjoyed this video please go ahead and subscribe to our YouTube channel by clicking on that circle on the left hand side if you want to check out some more options trading strategies go ahead and click on the play list on the right side [Music]

Channel: projectfinance

Views: 86,299

Rating: 4.9255319 out of 5

Keywords: long straddle option strategy, straddle option strategy, long straddle, option trading strategies, tastytrade, options trading, options trading strategies, stock market, options strategies, s&p 500, options trading for beginners, implied volatility, projectoption, trading options

Id: 4UlIMmXhjsc

Length: 16min 46sec (1006 seconds)

Published: Thu Mar 16 2017