Tuesday, March 15, 2011

Options 101: The Straddle

The long straddle consists of a call option and a put option with the same number of units, expiration, and strike price. It is a spread that involves the simultaneously buying of a put and a call. A long straddle has unlimited profit in either direction and limited risk. The costs to put on a long straddle is the debit, or premium paid. The debit is the maximum risk. A large move in the underlying would increase the value of the straddle. The passage of time hurts and an increase in volatility helps. Long straddles are attractive because of the unlimited profit potential. However, long straddles are considered risky because a large move is needed in order for the spread to be profitable. The break even price levels for the straddle are the strike price plus and minus the debit.

This is an example of a Citigroup March $4.5 straddle. In this straddle, the trader is long the $4.5 March put and long the $4.5 March call for a debit of $0.11. Therefore, the break even price levels are $4.39 and $4.61. In order for the spread to be profitable, the underlying stock needs to be lower than $4.39 or higher than $4.61 at or before March expiration.

In a short straddle, the trader would sell a call and a put with the same expiration and strike price. A short straddle has unlimited risk in either direction and limited profit potential. The costs to put on the short straddle is the credit, or premium received. The max profit is the credit. The trader does not want a large move in the underlying stock. An increase in volatility would hurt and the passage of time would help the spread. The break even price levels for the short straddle would be the strike price plus and minus the credit. For the spread to be profitable, the underlying stock would have to stay between the two break even prices at expiration.


  1. So if you look at this from a risk management perspective would this trade have been worth it to put on? How do you determine if the break even points are realistic? I understand what you are doing with the straddle and how you profit from it..but I struggle with the question should I put it on or not? Any help is appreciated...thanks!

  2. I shouldn't have said realistic...but what I really meant is attainable.

  3. Brian thats a great question. Unfortunately there isn't a 1 answer fits all. It really comes from knowing a name and being comfortable selling a specific implied volatility level/premium in hopes of buying it back cheaper and/or being comfortable going long or short the name at the strike price plus/minus the premium collected.

    This conversation can go on for much longer but a great example of a possibly good strangle sale (similar to a straddle sale but at different strikes) came today in TGT. You can review the trade in the Option flow recap. I hope that helps! keep the questions coming.

  4. awesome! Thanks for the post back...