What are the characteristics of this option strategy?
Straddle positions buy a call and a put at the same strike price and the same expiration, usually at the money, so the trade is a bet on the size of the move rather than its direction. A long straddle can profit whether the underlying rises or falls, but only if it travels far enough to cover both premiums, and the most that can be lost is the combined debit paid. The mirror image, a short straddle, sells the same two contracts, keeps a capped credit and carries uncapped loss on a large move either way. Everything below describes the long side unless it says otherwise.
Is this a bullish, bearish or neutral strategy?
The Straddle Option Strategy is a neutral strategy, meaning that it does not make a bullish or bearish bet on the direction of the underlying asset. However, if the underlying asset does make a significant move either up or down, this strategy can be used to capitalize on that move.
Is this a beginner or an advanced option strategy?
The Straddle Option Strategy is an advanced strategy that is only appropriate for experienced investors. Buying two premiums at once is expensive, and if the stock sits near the strike throughout the life of the options the entire debit is lost. A total loss of the premium paid is the normal outcome when the expected move does not arrive, not a rare one.
In what situation will I use this strategy?
The Straddle Option Strategy is typically used when the investor believes that the underlying asset is likely to make a large move in either direction, but is uncertain as to the direction of the move. This strategy takes advantage of the uncertainty by providing the ability to profit from either a large increase or decrease in the price of the underlying asset.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
This strategy has a low probability of profit and a large payoff when it works. In the best case a long straddle gains without limit as the underlying runs, and the downside gain is large but bounded because the stock can fall no further than zero. In the worst case the underlying sits at the strike and the whole debit is lost, which is the maximum loss on the long side. That maximum is known the moment the trade is opened.
How is this strategy affected by the greeks?
The Straddle Option Strategy is affected by the following greeks: delta, gamma, theta, and vega. Delta is the rate at which the option price changes with the underlying asset, while gamma is the rate at which delta changes with the underlying asset. Theta is the time decay of the option, and vega is the sensitivity of the option price to changes in volatility.
In what volatility regime (i.e VIX level) would this strategy be optimal?
A long straddle is bought when the move expected is larger than the one the options are already priced for. Paying two premiums when implied volatility is elevated is expensive and pushes both breakevens further away, so a high VIX is not by itself a reason to buy a straddle. The better setup is implied volatility that is low relative to the move actually expected, for instance ahead of a catalyst the market has not yet priced. Selling a straddle is the opposite reading of the same regime, and it carries the uncapped loss described above.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
Adjusting the Straddle Option Strategy when it goes against the investor is relatively straightforward. The investor can roll the untested leg closer to the money, close one leg to leave a directional long call or long put, or close the whole straddle and re-establish it around the new price. Be aware that any adjustment involving selling options uncovered converts this defined-risk position into one with substantially larger risk. The adjustment process is relatively straightforward and easy to execute.
Where does this strategy typically fall in the range of commissions and fees?
This strategy can be quite expensive due to the large number of options that typically need to be purchased. The commissions and fees associated with this strategy will depend on the broker, but typically range from 2 to 4 dollars per option contract traded.
Is this a good option income strategy?
A long straddle is not an income strategy. It is a net debit paid up front, and time decay works against it every day the underlying stands still. Selling straddles does collect income, but that version has uncapped loss above the upper breakeven and loss all the way to zero below the lower one, so the steady credit is paid for by an open-ended tail.
How do I know when to exit this strategy?
When the underlying asset has made a significant move in either direction, the investor should assess whether the potential profit is worth the risk taken. If the potential profit appears to be too small when compared to the risk taken, the investor should consider exiting the position.
How will market makers respond to this trade being opened?
Market makers on the other side of a straddle are short both contracts, so they hedge the delta in the underlying and mark implied volatility up when they see demand for both legs at once. Expect the quoted volatility to firm up ahead of a known event such as earnings, which is exactly when straddles are most in demand. Market makers do not set or discount your broker commissions.
What is an example (with calculations) of this strategy?
Take an underlying trading at $100. The investor buys the $100 call for $4.50 and the $100 put for $4.20, a combined debit of $8.70 per share, or $870 for one contract of each. That $870 is the entire risk on the trade.
The two breakevens sit one debit away from the strike in each direction: $108.70 on the upside and $91.30 on the downside. Note what that means for a move that looks helpful but is not big enough. At $105 the call is worth $5.00 and the put expires worthless, so the position returns $500 against $870 paid, a loss of $370. The same is true at $95 on the other side. The stock has to clear $108.70 or break $91.30 before the straddle makes money, and if it finishes exactly at $100 both contracts expire worthless and the full $870 is gone.
Sold instead of bought, those same two contracts form a short straddle that collects the $870 credit. Its profit is capped at that credit, its loss above $108.70 is uncapped, and its loss below $91.30 runs until the stock reaches zero. The capped loss described above applies to the long straddle only.
How can MarketXLS help?
MarketXLS provides investors with a powerful set of tools for analyzing and executing the Straddle Option Strategy. Our options analytics tool can help investors identify the ideal entry and exit points for the trade, while our powerful trading platform can help investors execute the trade quickly and efficiently. MarketXLS also offers a wide range of tutorials and videos that can help investors learn more about the various aspects of options trading and the Straddle Option Strategy in particular.
Here are some templates that you can use to create your own models
Short Straddle Option Strategy
Long Straddle Option Strategy
Strap Straddle
Long Put Synthetic Straddle
Strip Straddle
Calendar Straddle
Synthetic Short Straddle with Calls
Synthetic Short Straddle with Puts
Calendar Strangle
Short Strangle Option Strategy
Long Strangle Option Strategy
Strap Strangle
Strip Strangle
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic
Get RealTime Updated Option Prices
Synthetic Short Straddle With Puts Option Strategy
Overview of Synthetic Strangle Investing
Mastering the Strangle and Straddle Option Strategies
2 Leg Option Strategies