How Long Straddle Option Trading Strategy can be used for making profits in a volatile market?
A Long Straddle Options Trading is one of the simplest options trading strategy which involves a combination of buying a call and buying a put, both with the same strike price and expiration. Long Straddle option strategy can be used to make profit in a volatile market. It can generate good returns when the price of an underlying security moves significantly in either direction. It means that you don’t have to forecast the trend of the market, but you have to bet on the volatility.
When should you initiate a Long Straddle Option Trading?
If you believe that an underlying security is going to make a move because of events such as budget, monetary policy, earning announcements, etc., and also implied volatility should be at normal or at below average level, then you can buy call & put option. This strategy is known as long straddle trading.
How should you construct a Long Straddle Option Strategy?
Long straddle options strategy is implemented by buying at-the-money call option and simultaneously buying at-the-money put option of the same underlying security with the same expiry.
|Strategy||Buy ATM Call and Buy ATM Put|
|Market Outlook||Significant volatility in underlying movement|
|Upper Breakeven||Strike price of buy call + Net Premium Paid|
|Lower Breakeven||Strike price of long put - Net Premium Paid|
|Risk||Limited to Net premium paid|
Let’s try to understand this with an example:
|Nifty Current spot price||Buy ITM/ATM Call+ Sell OTM Call|
|Buy ATM Call & Put (Strike Price)||Rs. 8800|
|Premium Paid (per share) Call||Rs. 80|
|Premium Paid (per share) Put||Rs. 90|
|Upper breakeven||Rs. 8970|
|Lower breakeven||Rs. 8630|
|Lot Size (in units)||75|
Suppose, Nifty is trading at 8800. An investor, Mr. A is expecting a significant movement in the market, so he enters a long straddle by buying a FEB 8800 call strike at Rs. 80 and FEB 8800 put for Rs. 90. The net premium paid to initiate this trade is Rs. 170, which is also the maximum possible loss. Since this strategy is initiated with a view of significant movement in the underlying security, it will give the maximum loss only when there is no movement in the underlying security, which comes around Rs. 170 in the above example. The maximum profit will be unlimited if it breaks the upper and lower break-even points. Another way by which this options trading strategy can give profit is when there is an increase in implied volatility. Higher implied volatility can increase both call and put’s premium.
For the ease of understanding, we did not take into account commission charges. Following is the payoff schedule assuming different scenarios of expiry.
The Payoff Schedule:
|On Expiry NIFTY closes at||Net Payoff from Call Buy (Rs.)||Net Payoff from Put Buy (Rs.)||Net Payoff (Rs.)|
Analysis of Long Straddle Options Trading Spread Strategy
A Long Straddle Spread Strategy is best to use when you are confident that an underlying security will move significantly in a very short period of time, but you are unable to predict the direction of the movement. Downside loss is also limited to net debit paid, whereas upside reward is unlimited.
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