Options

The straddle is a terrific options trading strategy for traders of all levels. We take a look at their key characteristics, tips to help you profit and more.

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

 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.

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

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

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.

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).

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.

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.

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 

 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.

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).

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.

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.

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.

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.

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.

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).

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).

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.

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).

Removing the long call converts the straddle into a bearish 

 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.

Selling the long put flips the straddle to a bullish 

. 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.

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.

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).

, let’s see how a straddle can be applied in the real world.

 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.

Here are the steps needed to open the trade:

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.

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.

Once you’ve selected a strike, an order placement ticket will appear, displaying information on the option price, 

, and the most recent trades made by other traders.

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.

Straddle Options Strategy: How to Consistently Make Profits

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