The Option Profit

Straddle

A straddle is entered into when an investor goes long or short the same number of put and call contracts on the underlying with each contract having the same strike price and expiration date. In a long straddle, an investor anticipates high volatility and goes long both the put and the call contracts. The investor now has the potential to profit from large moves in the underlying in either direction. If the underlying moves in either direction more than the combined cost of the premiums, the investor realizes the difference. In a short straddle the investor anticipates minimal volatility thus selling both the put and the call. The investor collects the premium for the sell of each position. If the total premium collected is greater than the cost to cover the losing position, the investor realizes a gain. Below are hypothetical examples of straddle trades and how they could be profitable assuming XYZ is at 100.

Long Straddle

If the investor expects high volatility she would buy the May XYZ 100 call for $3 and buy the May 100 XYZ put for $3. On expiration, if XYZ is trading above 106 or below 94, she would realize the difference. If XYZ closes at 107 she realizes a $1 gain.

The Math

long call contract ($3) + long put contract ($3) = ($6) + $7 gain on the 100 call = $1 gain.

Short Straddle

If the investor expects minimal volatility he would sell May XYZ 100 call for $3 and sell the May XYZ 100 put for $3. On expiration, if XYZ closes below 106 or above 94, he realizes the difference. If XYZ closes at 95 he realizes a $1 gain.

The Math

short call contract $3 + short put contract $3 = $6 - $5 loss on the 100 put = $1 gain.

Strangle

A strangle utilizes a strategy similar to the straddle but incorporates two strike prices.

Long Strangle

If the investor expects high volatility he would buy the May XYZ 110 call and for $1 buy the May XYZ 90 put for $1. On expiration, if XYZ closes above 112 or below 88, he realizes the difference. If XYZ closes at 113 he realizes a $1 gain.

The Math

Long call contract ($1) + long put contract ($1) = - $2 + $3 gain on the 110 call = $1 gain.

Short Straddle

If the investor expects minimal volatility he would sell May XYZ 110 call for $1 and sell the May XYZ 90 put for $1. On expiration, if XYZ closes below 112 or above 88, he realizes the difference. If XYZ closes at 89 he realizes a $1 gain.

The Math

short call contract $1 + short put contract $1 = $2 - $1 loss on the 90 put = $1 gain.

Refer to Glossary for terms and definitions

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RISK is inherent in any investment. No individual or entity should invest with funds they cannot afford to lose. Option trading is time sensitive and involves risk including, but not limited to, loss of gains and principal. A leveraged investor risks the loss of more than principal. Options do not have to be held until expiration and can be exercised at any point. Option trades can be closed prior to expiration with a gain or loss being realized. It is important that you understand all trades and the risk associated before executing a transaction. The Option Profit provides broad ideas, not individual recommendations, and is not responsible for any losses incurred. Diversification is important with any strategy and should be considered when investing Before trading consult with a financial advisor to determine if option trading is appropriate for you and your financial goals.