Options allow investors and traders to enter into positions and to make money in ways that are not possible simple by buying or selling short the underlying security. If you only trade the underlying security, you either enter a long position buy and hope to profit from and advance in price, or you enter a short position and hope to profit from a decline in price.
Your only other choice is to hold no position in a given security, meaning you have no opportunity to profit. Through the use of options, you can craft a position to take advantage of virtually any market outlook or opinion. Case in point is a strategy known as the long straddle. Entering into a long straddle allows a trader to profit if the underlying security rises or declines in price by a certain minimum amount. This is the type of opportunity that is only available to an options trader.
Learn the basics of options investing, as well as advanced concepts like straddles, strangles and spreads, through simplified, detailed explanations and real-time trades in Investopedia Academy's Options for Beginners course ].
Mechanics of the Long Straddle A long straddle position is entered into simply by buying a call option and a put option with the same strike price and the same expiration month. An alternative position, known as a long strangle , is entered into by buying a call option with a higher strike price and a put option with a lower strike price.
In either case, the goal is that the underlying security will either:. The risk in this trade is that the underlying security will not make a large enough move in either direction and that both the options will lose time premium as a result of time decay. The maximum profit potential on a long straddle is unlimited. The maximum risk for a long straddle will only be realized if the position is held until option expiration and the underlying security closes exactly at the strike price for the options.
For more, see What's the difference between a straddle and a strangle? These breakeven points are arrived at by adding and subtracting the price paid for the long straddle to and from the strike price. These two positions therefore offset one another, and there is no net gain or loss on the straddle itself. Here again, these two positions offset one another and there is no net gain or loss on the straddle itself.
Showing a Profit Now let's look at the profit potential for a long straddle. As mentioned earlier, the profit potential for a long straddle is essentially unlimited bounded only by a price of zero for the underlying security.
At the same time, the 50 strike price put would be worthless. Advantages and Disadvantages of the Long Straddle The primary advantage of a long straddle is that you do not need to accurately forecast price direction. Whether prices rise or fall is not important. The only thing that matters is that price moves far enough prior to option expiration to exceed the trades' breakeven points and generate a profit.
Another advantage is that the long straddle gives a trader the opportunity to take advantage of certain situations, such as:. Typically, stocks trend up or down for a while then consolidate in a trading range. Once the trading range has run its course, the next meaningful trend takes place. Often during extended trading ranges, implied option volatility declines and the amount of time premium built into the price of the options of the security in question becomes very low.
To learn more, read Implied Volatility: Finally, many traders look to establish long straddles prior to earnings announcements on the notion that certain stocks tend to make big price movements when earnings surprises occur, whether positive or negative. As long as the reaction is strong enough in one direction or the other, a straddle offers a trader the opportunity to profit.
The Bottom Line Different traders trade options for different reasons, but in the end, the purpose is typically to take advantage of opportunities that wouldn't be available by trading the underlying security. The long straddle is a case in point.
A typical long or short position in the underlying security will only make money if the security moves in the anticipated direction. Likewise, if the underlying security remains unchanged, no gain or loss occurs. With a long straddle, the trader can make money regardless of the direction in which the underlying security moves; if the underlying security remains unchanged, losses will accrue. Given the unique nature of the long straddle trade, many traders would be well-served in learning this strategy.
Dictionary Term Of The Day. Broker Reviews Find the best broker for your trading or investing needs See Reviews. Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. A celebration of the most influential advisors and their contributions to critical conversations on finance. Become a day trader. Learn the basics of options investing, as well as advanced concepts like straddles, strangles and spreads, through simplified, detailed explanations and real-time trades in Investopedia Academy's Options for Beginners course ] Mechanics of the Long Straddle A long straddle position is entered into simply by buying a call option and a put option with the same strike price and the same expiration month.
In either case, the goal is that the underlying security will either: Rise far enough to make a larger profit on the call option than the loss sustained by the put option, or Decline far enough to make a larger profit on the put option than the loss sustained by the call option The risk in this trade is that the underlying security will not make a large enough move in either direction and that both the options will lose time premium as a result of time decay.
Another advantage is that the long straddle gives a trader the opportunity to take advantage of certain situations, such as: An anticipated breakout following a period of consolidation Extremely low option time premiums based on low implied option volatility Upcoming earnings Typically, stocks trend up or down for a while then consolidate in a trading range.
The primary disadvantages to a long straddle are: Traders must pay two premiums, not just one. The underlying security must make a meaningful move in one direction or the other in order for the trade to generate a profit.
How much a fixed asset is worth at the end of its lease, or at the end of its useful life. If you lease a car for three years, A target hash is a number that a hashed block header must be less than or equal to in order for a new block to be awarded. Payout ratio is the proportion of earnings paid out as dividends to shareholders, typically expressed as a percentage. The value of a bond at maturity, or of an asset at a specified, future valuation date, taking into account factors such as No thanks, I prefer not making money.
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