Topics Options
Bybit Learn
Bybit Learn
Intermediate
Aug 16, 2022

Straddle Options Strategy: How to Consistently Make Profits

A straddle is a price-neutral options strategy used to take advantage of changes to an underlying asset's implied volatility (IV).

There are two types of straddle:

  1. Long Straddle — Benefits when IV rises (long vol)

  2. Short Straddle — Benefits when IV falls (short vol)

To initiate a long straddle, you buy a call option and a put option with the same strike price and expiration date. For the strategy to make money at expiration, the price of the underlying asset must deviate from the strikes (in either direction) by an amount greater than the total premium paid.

For a short straddle, the opposite applies. Here, you sell a put and call with the same strike price and expiration date. To profit at expiration with this approach, the underlying asset mustn’t deviate from the strikes by more than the total amount of premium collected.

Straddle Setup

Whether it's a long or short position, three things apply when setting up a straddle.

  1. The call and put option must be tied to the same underlying asset.

  2. Both options must have the same expiration date.

  3. You must use the same strike price for both the put and the call.

Long Straddle Setup

Let's see how long straddles can be used to profit from growing volatility in various assets.

Stock Options Example

Here’s a hypothetical scenario: In two weeks' time, Apple Inc. (NASDAQ: AAPL) will report their quarterly earnings for Q1. The stock has been trading in a tight range for weeks (low volatility) and you predict this could change post-announcement … but you’re just unsure in which direction. With this in mind, you decide to enter into a long straddle.

Underlying Security Price: $150.00 per share

  1. Buy 1 contract (100 shares) of the $150.00 put option, with 30 days to expiration (DTE), paying a $3.00 premium ($3.00 per share × 100 shares = $300 total cost).

  2. Buy 1 contract of the $150.00 call option with 30 days to expiration, paying a $3.00 premium ($3.00 per share × 100 shares = $300 total cost).

This example uses at-the-money (ATM) strikes (equal to the underlying security's price). Alternatively, out-of-the-money (OTM) strikes can be implemented to give the trade a bullish or bearish bias.The combined cost of the strategy is a net debit of $6.00 per share ($600), which is also the maximum potential loss.

For this trade to make money, AAPL’s price must be above $156.00 (call strike + total premium paid) or below $144.00 (put strike − total premium) at expiration.

The payoff diagram below illustrates the long straddle's risk profile at expiration. You'll notice the maximum loss occurs when the stock expires equal to the long strikes.

The strategy has unlimited profit potential on the upside and significant profit potential on the downside (underlying security cannot trade below $0.00).

long straddle payoff diagram

Source: The Options Playbook

Crypto Example

Let’s say in five days' time, the Federal Open Market Committee (FOMC) will announce whether they’ll adjust U.S. interest rates. Previous interest rate decisions have resulted in a significant increase in BTC volatility, so you decide to establish a long straddle using weekly options, in order to benefit if a large move occurs.

  • Underlying BTC price of $20,000

  • Buy a 1.0 BTC $20,000 put option with 7 DTE, paying a $500 premium

  • Buy a 1.0 BTC $20,000 call option with 7 DTE, paying a $500 premium.

Here, the cost is a net debit of $1,000 (before transaction fees).

For this trade to make money at expiration, BTC must be above $21,000 (call strike + total premium) or below $19,000 (put strike − total premium).

Unless BTC settles at exactly $20,000 (ATM) at the time of expiration, one strike will be in-the-money (ITM) and the other OTM, guaranteeing you won't lose all of your invested capital.

Short Straddle Setup

Using AAPL as an example again, let’s see how we can benefit from a short strangle.

As predicted, Apple’s stock was extremely volatile after the release of its earnings report, which showed a sharp slowdown in sales in the last quarter (Q1.) Because of the negative news, AAPL’s price has been fluctuating widely between $130.00 and $145.00. Subsequently, its IV jumped from 30% to 50%, causing its option prices to rise.

However, you expect the underlying security's price movement to slow in the coming weeks, so you decide to open a short straddle (short vol) to take advantage of the high volatility.

  • Underlying Security Price: $140.00 per share

  • Sell 1 contract (100 shares) of the $140.00 put option, with 30 DTE, receiving a premium of $5.00 per share ($5.00 per share × 100 shares = credit of $500)

  • Sell 1 contract (100 shares) of the $140.00 call option, with 30 DTE, receiving a premium of $4.00 per share ($4.00 per share × 100 shares = credit of $400).

You'll notice that although both strikes are ATM, with the same number of days to expiration as the earlier example, the premiums involved are much higher. This is because option premiums increase when volatility does, and decrease with a drop in volatility.

Another difference is that here, the put option is more valuable than the call. This reflects a greater demand for puts following AAPL’s unfavorable earnings.

The combined premiums add up to a net credit of $9.00 per share ($900), which is also the maximum profit you can earn.

For this trade to be profitable at expiration, the share’s price must settle between $131.00 (put strike − premium received) and $149.00 (call strike + premium received).

Unlike the long straddle, which has limited risk (premium paid), the short straddle has limited profit potential (premium received) and significant risk.

The payoff diagram below depicts a short straddle achieving maximum profit when both strikes expire ATM. There’s unlimited loss potential on the upside, and significant loss potential on the downside (underlying security cannot trade below $0.00).

short straddle payoff diagram

Source: The Options Playbook

Straddle vs. Strangle Options

The straddle and strangle share many similarities. They are both price-neutral and structured to benefit from changes in IV. However, while a straddle uses ATM strikes, a strangle combines two OTM options.

For a long strangle, you purchase an OTM put option and an OTM call option on the same underlying asset, with the same expiration date.

Like the long straddle, a long strangle benefits when volatility increases. The key difference between the two is that by using OTM strikes, you need a larger move in the underlying asset for the strangle to turn a profit. The payoff is that, all things equal, two OTM options should cost less than two ATM options.

Like the long straddle, a long strangle is low-risk (total premium), with unlimited profit potential on the upside and considerable potential gains on the downside.

The payoff diagram below shows the trade is unprofitable in a wider range than the straddle, becoming profitable when the underlying asset price moves beyond either strike by more than the total premium cost.

long strangle payoff diagram

Source: The Options Playbook

A short strangle, pictured below, is a mirror image of the long strangle strategy. While you collect a lower amount of premium by selling OTM options, the range where the trade is in profit is wider than when selling a straddle.

short strangle payoff diagram

Source: The Options Playbook

Who Can Use the Straddle Strategy?

Because the long straddle is a low-risk strategy, it's appropriate for investors of all levels of experience. In contrast, the short straddle is better suited to experienced traders with a high tolerance for risk.

When to Use a Straddle

The best time to employ a straddle is when you expect volatility to rise and the underlying asset to record a “sufficiently large” movement (by more than the amount of premium received).

Options traders often use the straddle to coincide with potential market-moving events, such as economic data releases and regulatory hearings, or simply when their technical analysis forecasts an impending breakout.

Breakeven Point

Both long and short straddles have two possible breakeven points at expiration — when the market settles in either direction, equal to the amount of premium either paid or received.

Example 1

A long BTC straddle centered at the $20,000 strike price, with a combined premium cost of $1,000, will break even at either $19,000 or $21,000 on the expiration date. At both levels, the trade neither makes nor loses money (strike price − settlement price +/− premium paid).

Example 2

A short straddle centered at the $20,000 strike price generating $1,000 in premium also breaks even at $19,000 or $21,000 (strike price − settlement price +/− premium received).

Short Straddle Sweet Spot

The sweet spot for a short straddle is when the options expire with the underlying price equal to the strikes. Using the above example, the sweet spot is $20,000 at expiration. Because both options are ATM, they expire worthless and you get to keep the entire premium.

Adjustments to Make in Bearish Markets

As mentioned earlier, the straddle is designed to profit from both bullish and bearish markets. However, you can modify the strategy if your market view changes during the trading process. Here, we look at two ways you can switch the strategy from price-neutral (horizontal) to directional (diagonal).

Sell the Long Call Option (Bearish)

Removing the long call converts the straddle into a bearish long put. Although the risk remains limited (put premium +/− the cost of closing the call), the trade now has a bearish bias and doesn't profit if the underlying asset moves above the long call's breakeven price.

Sell the Long Put Option (Bullish)

Selling the long put flips the straddle to a bullish long call. Similar to removing the put option, the trade's risk is limited (call premium +/− the cost of closing the put), but no longer profits if the market moves below the closed long put's breakeven point.

Maximum Take-Profit Potential

In theory, the strangle has unlimited profit potential. While that sounds appealing, however, it's extremely unlikely to happen in reality.

For that reason, it's good practice to set some predetermined take-profit levels. One tactic you can use to lock in profits from a long straddle is to close the position incrementally (sell a set % of both calls and puts) if IV increases. This ensures that you cover some or all of the cost of the transaction, remaining open to more profits on the balance of the open position.

Maximum Incurred Loss Potential

We know the maximum you can lose when trading the long straddle is the upfront cost of the trade. However, that doesn't mean you have to lose all of your investment if the trade isn't going your way. Sometimes, closing the position ahead of expiration could be a good choice.

The price you pay for the fixed risk of any long option is the negative effects of time-decay (theta) and decreasing IV.

All options lose value over time, eventually reaching zero time value at the time of expiration. For this reason, the long straddle requires the IV element of its value to increase by more than it loses each day to time decay.

Consequently, long straddle holders often decide to close their position (sell both the put and call) before theta is at highest (approaching expiration).

Trading the Straddle on Bybit

Turning to the BTC Perpetual futures chart, let’s see how a straddle can be applied in the real world.

The below example shows BTC has been trending broadly sideways for around two months. Notably, the price is encountering resistance around the $24,000 level. In light of this, you expect a large move on the horizon and decide to open a long straddle centered at the $24,000 strike prices.

trading the straddle on bybit

Source: Bybit

Here are the steps needed to open the trade:

Step 1

Under Derivatives, select USDC Options.

trading the straddle on bybit (step 1)

Source: Bybit

Step 2

At the BTC option chain page, select your desired expiration date (or view all the expiration dates together). This example shows the available BTC options that have 2-09-22 (Sept. 2, 2022) as their expiration date.

trading the straddle on bybit (step 2)

Source: Bybit

Step 3

Select the strike prices you wish to trade. Call options are displayed on the left-hand side of the option chain, and put options on the right.

trading the straddle on bybit (step 3)

Source: Bybit

Step 4

Once you’ve selected a strike, an order placement ticket will appear, displaying information on the option price, Greeks, and the most recent trades made by other traders.

trading the straddle on bybit (4.1)

Source: Bybit

By scrolling down, you’ll be able to view the payoff diagram for your strategy, which shows the P&L (profit & loss) potential at expiration.

trading the straddle on bybit (step 4.2)

Source: Bybit

Once you select your order size and direction (buy or sell), the margin requirement is calculated and shown at the bottom of the order ticket.

If you wish to proceed, click on Place Order.

Step 5

Ensure that all of the details are correct and select Confirm to send your order to the exchange.

trading the straddle on bybit (step 5)

Source: Bybit

Step 6

With the first strike completed, repeat the process for the second strike to finish the transaction.

Straddle Tips

Here are three strategies to increase the likelihood of a long straddle turning profitable:

  1. Time your strategy to coincide with potentially market-moving events.

  2. Close the position if volatility spikes soon after entering the trade.

  3. Choose a strike price that represents a turning point on the price chart, such as a long-term resistance or support level.

Margin Requirements

One of the straddle's key advantages is its minimal margin requirement. Because the most it can lose is the cost of entry, there’s no need for further margin once you’ve paid the initial net debit.

In contrast, the margin requirement for a short strangle is considerably higher. That being said, Bybit traders with a minimum account balance of 1,000 USDC can choose to activate Portfolio Margin mode.

Portfolio Margin mode uses a risk-based approach similar to Standard Portfolio Analysis of Risk (SPAN) to determine the overall risk level of a crypto portfolio. Using this method, long and short exposures are netted against each other, thus reducing margin requirements for hedged portfolios. For this reason, an existing long or short position may reduce the margin requirement for a short straddle applied to the same underlying asset.

Theta Decay Impact

As we’ve explained, options premiums lose value (erode) over time. However, time decay isn't constant, and changes while the contract is active. The measure for gauging how much a premium will lose each day is theta.

Theta measures a premium's sensitivity to time. Because theta always reflects the amount by which an option will decline, it's always denoted as a negative number. For instance, all things being equal, a BTC option valued at $100.00 with a theta of −0.5 will be worth $99.50 the following day, whereas if the option had a theta of −0.9 it would be worth $99.10 the following day.

The theta curve below demonstrates that time decay is not linear. Since there’s less time for the option to realize or increase in value, the rate of erosion accelerates as the expiration date approaches.

Source: Born To Sell Options, LLC

Implied Volatility Effect

The influence of implied volatility determines whether a long straddle will be profitable. Higher IV increases the odds of a sufficiently large move happening in the underlying asset for the trade to pay off at expiration.

How does option price change when IV does? To determine this, we can use another Greek called vega.

Vega calculates a premium's sensitivity to a 1% change in IV. For example, a BTC option with a vega of 0.5 will increase by $0.50 if the IV moves higher by 1%, and decrease by $0.50 if the IV falls by 1%.

Similar to theta, vega is correlated with time. Longer-dated options have higher vega (are more sensitive to changes in IV) than shorter-dated options.

With this in mind, if the IV rises soon after initiating a long straddle trade, it may be advantageous to liquidate the position and realize your profit. This also works to combat the negative effects of time decay as the option approaches expiration.

implied volatility (iv) effect

Source: Rattibha.com

Pros

  • Long straddles are ideal if you anticipate a major move following news of an upcoming event, but are unsure of the direction it will take.

  • The strategy's set cost means you can calculate your greatest possible loss.

  • Profit potential is limitless on the upside and significant on the downside.

Cons 

  • Time decay works against this strategy.

  • A drop in IV might make your trade unprofitable.

Risks

  • The expected increase in IV may fail to materialize, causing both the put and call option to lose value.

  • The underlying moves, but not by enough to offset the effects of time decay.

In a Nutshell

Long straddles and strangles are excellent risk-averse strategies which you can use to profit from rising IV. As both methods are easy to apply, they may be employed by less experienced traders looking for big returns. Short strangles and straddles, on the other hand, are more appropriate for more experienced traders or those with a higher tolerance for risk.

If you're still unsure whether straddles or strangles are right for you, take a look at Bybit Learn's free educational tools to discover more about the benefits of crypto options.

Trade The Straddle Options Strategy on Bybit Today