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WIKI ANALYSIS| This article is part of WikiProject Definitions. Consider editing to improve it. View articles referencing this definition. |
A Straddle is a neutral options trading strategy that involves buying a call option and a put option at the same strike price. A straddle is a neutral options strategy because it's profitability is independent of the direction of any movement in the underlying stock.
Long Straddle
A trader establishes a long straddle by simultaneously purchasing a put option and a call option at the same strike price and expiration date. A long straddle profits from an increase in implied volatility and any substantial move in the price of the underlying asset. As with any long strategy, a long straddle suffers from the effects of time decay. If the price move in the underlying occurs over a long period of time or the move is not large enough the position will be a loss at expiration.
Payoff
Short Straddle
A trader establishes a short straddle by simultaneously selling a put option and a call option at the same strike price and expiration date. A short straddle is a bet that implied volatility will decrease or that the price of the underlying will not move substantially during the life of the options. If the price of the underlying asset increases or decreases quickly during the life of the option then the position will incur a loss. Otherwise the profit will be equal to the amount of premium collected when the position is established.
Stock + Short Straddle
If you want to own a stock, you can combine the purchase with a short straddle to purchase the stock at a discount. Suppose you purchase 100 shares of MSFT at $25 and then sell one $25 Call and one $25 put, 6 months out, for about $2.50 each. The premium received on the option sales reduces your cost basis in the trade by $5. So you pay net $20/share instead of $25. If MSFT is higher at expiration, the stock will be called away from you at $25 for a 25% gain. If it is lower at expiration, you will be put 100 additional shares at $25, for a net cost basis of $22.50/share, a 10% discount on today's price. For stocks with higher implied volatility, the gain or discount is even greater.
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