What is a Straddle Options Strategy and How to Create It?

What is a Straddle Options Strategy and How to Create It?

The straddle options strategy is used in a neutral market. Discover its types and how to create this strategy
09 May, 2024 10:00am
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Different options strategies are designed to help you profit from different market movements. Some can help you in a bullish market while others may be more useful in a falling market. However, you may not always be able to anticipate the direction of price change in the underlying asset. In such cases, the straddle options strategy may be able to help you capitalise on the price movements no matter what the direction of change may be. 

 

Let us take a closer look at what the straddle strategy entails, the types of this strategy and its potential outcomes in different market conditions.

 

What is the Straddle Strategy?

In options trading, the straddle strategy is a technique that involves taking a similar position in two different types of options contracts. In other words, you take a long (or short) position in a put option and a call option of the same underlying asset, with the same expiry and strike price.

 

The straddle is a neutral options trading strategy — meaning that it is best used when you are not sure of the direction in which the price of the underlying asset may move. Depending on the extent of price movement expected, you may take a long position or a short position in the two types of options. This leads us to two types of straddle options strategies.

 

Types of Straddles 

Based on the type of position you take to set up the straddle, the strategy can be one of two types — namely a long straddle or a short straddle. Let us take a closer look at what each type of straddle options strategy entails. 

 

  • Long Straddle 

In a long straddle strategy, you buy a put option and a call option with the same expiry and strike price. In other words, you take a long position in the options. Typically, this type of straddle strategy is best used when you don't know which direction the price may move, but you expect a strong price movement in either direction.

 

So, the essence is that if the price moves substantially enough in any one direction, the profits from the option that's ‘in-the-money’ because of such a price movement may offset the loss (of the premium paid) from the other option. 

 

  • Short Straddle 

In a short straddle, you sell a put option and a call option with the same underlying asset, expiry and strike price. This means you take a short position in the market and sell or write options. A short straddle options strategy is ideal when you have a neutral non-volatile outlook, meaning that you expect the price to remain within an expected range. 

 

So, you anticipate that both options sold will expire worthless or out-of-the-money. This way, you can profit from the premiums earned on the options written.

 

Creating and Decoding the Long Straddle 

Creating a long straddle strategy is simple. You only have to purchase a put option and a call option. Let us discuss an example to decode this strategy better.

 

Say the current price of a stock is Rs. 400. You buy a call option at a premium of Rs. 30 and a put option at a premium of Rs. 80 — each with a strike price of Rs. 450 and the same next-month expiry.

 

Now, at the time of expiry, the stock price can be significantly above or below the strike price. Let's decode each of these scenarios.

 

  • Scenario 1: Stock Price is Rs. 620

In this case, though the put option expires worthless, the call option gives you a profit worth Rs. 170 (i.e. Rs. 620 — Rs. 450). So, your net gains from this position will be Rs. 60 (i.e. Rs. 170 — Rs. 80 — Rs. 30). 

 

  • Scenario 2: Stock Price is Rs. 250

Here, though the call option expires worthless, the put option gives you a profit of Rs. 200 (i.e. Rs. 450 — Rs. 250). So, your net gains from this position will be Rs. 90 (i.e. Rs. 200 — Rs. 80 — Rs. 30). 

 

Creating and Decoding the Short Straddle 

To create a short straddle strategy, you need to sell a put option and a call option. Let us take an example to decode this strategy further.

 

Suppose that the current price of a stock is Rs. 400. You sell a call option at a premium of Rs. 30 and a put option at a premium of Rs. 80 — each with a strike price of Rs. 450 and the same next-month expiry.

 

Now, when the options expire, you expect the price to remain relatively stable and not move significantly in either direction. Let's see what happens if the stock price moves slightly in either direction. 

 

  • Scenario 1: Stock Price is Rs. 430

In this case, though the call option expires worthless, the put option leads to a loss of Rs. 20 (i.e. Rs. 450 — Rs. 430). So, your net gains from this position will be Rs. 90 (i.e. Rs. 80 + Rs. 30 — Rs. 20). 

 

  • Scenario 2: Stock Price is Rs. 480

In this case, though the put option expires worthless, the call option leads to a loss of Rs. 30 (i.e. Rs. 480 — Rs. 450). So, your net gains from this position will be Rs. 80 (i.e. Rs. 80 + Rs. 30 — Rs. 30). 

 

Conclusion 

Setting up the long straddle or the short straddle manually can be time-consuming and prone to errors. You may not be able to deploy the strategy promptly and capitalise on the prevailing market conditions. Here is where the Motilal Oswal Research 360 platform can be a game-changer.

 

On this comprehensive financial market analysis tool, you can visit the ‘Options Strategy’ section to find and set up options trading strategies for different expected market conditions like bullish, bearish, neutral volatile and neutral non-volatile scenarios. To set up a long straddle, you need to choose the neutral volatile scenario, while to set up a short straddle, you need to select neutral non-volatile market conditions. Sign up on this platform today to make options trading more effective with the right strategies. 

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