Papale on the Straddle Strategy

If you are reading this chances are you are not one of the three winners of Wednesday’s $448mm lottery jackpot.  And since I am writing I guess I did not win either.   I actually did not play.  I rarely play the lottery.  I buy out of the money calls.

With markets moving between manic and depressive, it’s sometimes hard to know whether to be long today, short tomorrow or something quite the opposite.  Well, for those who just can’t stay on one side of the market for very long there is an option based solution.  If we expect the market to move but not sure which way, one effective strategy might be a long straddle.  Buying a straddle means buying a call and a put at the same strike, generally near or at the money.  By doing this we are able to profit whether the market goes up or down.  The risk in this strategy is if the market does not move or moves very little, the value of straddle can diminish significantly.  However, like all debit spreads, it can only lose what we pay for it.

For example, if we pay $4 for a ABC straddle, the underlying must move at least $4 above or below the strike price to breakeven.  Anything beyond those points is profit.  Our total risk is $4.  Watch also the theta and vega of the spread.  Since we are long both the call and put generally close to the at the money strike, both these greeks can be significant.  However if a trader or investor is nervous but unsure of market direction, this can be a strategy that has the potential to pay off handsomely.

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