General
Straddle is both an efficiency-saving approach and a profitability-improvingapproachandisusuallyadopted by investors when they anticipate much to occur in the direction of the price of an underlying without knowing the direction. In straddle, a put and a call with the same expiry would be bought by an investor but also the same strike. This two-point strategyworks when a trader witnesses volatility, including earnings season, significant market events, or news releases capable of producing price action in eitherdirection. A straddle is used mainly for makingmoney through colossal price action in either direction. The seller will earn a profit if the underlying price moves enough in one direction or the other to cover the cost of purchasing both the put option and the call option and leave some amount. The theoretical maximumprofit on a straddle is unlimited if the underlying stock increases or decreases because the rise in the call option price or the fall in the put option price is unlimited. Or the wild loss is caught by the cost paid on either of the alternatives, and this will occur when the price of the underlying asset does not move sufficiently in either direction to cover the cost of the strategy. The volatility is what paysfor the strategy—the greater the spread in the asset price from the options' strike prices, the greater the terminal profit. A large price movement in either direction will win on the call or put and lose on the other. But if the price is stable or moves a smallamount, the call and put options will both lose becauseof the time-value factor and canmake worthless, and premium paid on both the options will be lost. Another one of the big things to rememberwhileemploying a straddle is option cost. Since both the call and put options are bought, the strategy is extremelyexpensive, especially when the underlying security is extremely volatile or the options'maturitydateisextremely distant.Thepriceof the options dependsonthe asset's volatility, expiry date, and strike price compared to the current price of the underlying asset. The more volatile the asset, the higher the premiums on the options, and that will increase the cost of the straddle. Because the strategy relies on dramatic price movement in which to profit, straddles are generallyused when investors expect an event thatwill induce such movement. Earnings reports, releases of economic information, mergers and acquisitions, or regulatory decisions are all kinds of events that cancreate the kind of volatility that would warrant a straddle position. The straddle is agreat trade for aperson who has no clue whatsoever in which direction the price of an asset will go but iscertain that there will be lotsof movement. This renders the strategy morethan worth it when volatility is skyrocketing, therebydriving the cost of volatility to stratospheric levels, i.e., just before earnings season or incaseof this humongous geopolitical event brewing. The second factor that one needstoconsider if one wasusing a straddle is the expiry date. The response is that the earlier the expiration date, the shorterthe time the options have to moveprofitably, and therefore the asset price will have to move faster in order to compensatefor the straddle. The traders will need to balance the time and the event or volatility anticipatedsincethe strategy will be losing even when it should be advancingsince the options are losing their time value too rapidly. It also needs to be held onceentered. When the asset is trending heavily in aparticular direction, the investors will choose to hedge the losing side of the position (the out-of-the-money option through price action) to lock profit and limit loss. The rest would choose to rebalance the position by rolling the options to a future expiration or new strike, respectively, depending on asset movement. Suchactions, however, make it costly and cumbersome for the strategy. The straddle is a good idea when there is anticipated price movement but not in direction since it is a volatility play and not a directional play. One of the negativefeatures of a straddle, however, is that gigantic losses are guaranteedifthereislittle price movement or nopricemovementatall. Here, the entireoptions premium goestowaste for the trader, something that can be ahighlydangerousbet if the options are extremelyexpensive. Option Income Strategy for Swing Traders is very time-sensitive; if the direction of the price movement or the amount of movement is misconceived by the trader, then the straddle will be a loss. Toreduce this risk, apart of the traders also employssome other methodssuchaspurchasing the longer duration straddles or rolling over the position in succession of time and that is reducing the cost insteadofemploying the standard approach.
